In plain English
Strategies are chosen by people whose incentives may differ from the owners', and are executed in a world nobody can forecast. Good corporate strategy therefore designs incentives deliberately and prefers plans that survive several futures over plans that are optimal in one.
The advanced view
Agency conflicts run owner-manager (free cash flow, empire building, horizon problems) and majority-minority (tunnelling, pyramidal ownership, dual-class shares, common in Nordic holding structures). Governance instruments — board composition, equity-linked pay with long vesting, leverage as a disciplining device, activist pressure, the market for corporate control — are substitutes. Under Knightian uncertainty, scenario planning and real options replace point forecasts: value the right to wait, stage, expand or abandon rather than committing on an expected value.
Frameworks
Agency instruments
Pay design, board independence, ownership concentration, debt covenants, takeover threat.
Stakeholder view
Value creation requires committed non-shareholder investments (employees, suppliers, communities) that contracts cannot fully protect.
ESG as strategy
Where it changes cost of capital, licence to operate or willingness to pay it is strategy; otherwise it is reporting.
Scenario planning
Two critical uncertainties, four worlds, one set of no-regret moves plus option-like bets per world.
Real options
Defer, expand, contract, abandon, switch. Value rises with volatility, unlike a DCF.
Staged commitment
NPV(commit now) = −I + PV(cash flows) Staged: pay pilot cost p now, invest I only if signal is good Value = −p + P(good) × max(0, NPV | good) Option is worth more when volatility and irreversibility are high
Worked example — pilot versus full build
Step 1 of 6
- 1Full build: I = 200, PV = 260 if demand is high, 90 if low; P(high) =
Common pitfalls
- ×Treating an uncertain project as dead when its option value is positive.
- ×Scenario exercises with four scenarios and no decision attached to any of them.
- ×Ignoring who actually controls the vote when recommending a strategy.
- ×Assuming ESG claims translate into cash flow without a pricing or cost mechanism.
Must know cold
- ✓Free cash flow plus weak governance predicts value-destroying acquisitions.
- ✓Real option value rises with volatility; DCF value falls with it.
- ✓Scenario planning output is a decision rule, not a forecast.
Exercises
Try each one on paper before revealing the worked solution.
Exercise 1
A board proposes an all-share acquisition that raises EPS but lowers ROIC below WACC. What is the governance read, and what would you ask for?