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Chapter 4. Inflating the Bubble: the Fin... > When Economic and Financial Value Di...

When Economic and Financial Value Diverge

For a number of reasons, financial value can be well above, or well below, economic value. During the great bubble, financial values became enormously inflated compared to economic values, and when that was finally realized by investors, financial values collapsed well below the economic values

Figure 4-3 (The Bubble Curve) illustrates the divergence of economic and financial value for a single start-up. While the company is slowly building economic value, the financial markets accord it increasingly large financial value. Expectations far outrun actual performance. Then suddenly the financial markets realize their mistake, and the financial value of the firm comes tumbling down. As it overshot in the upward direction, now the Financial Value Chain overshoots in the downward direction, and financial value falls below economic value for the firm. From the point of view of the firm, nothing has happened to justify either the rapid inflation of its financial value, or the sudden collapse of financial value—all along the company has been executing successfully its business plan. The wild ride is all in the stock market.


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