"Network Externalities in Corporate Financial Management"
Nonlinear network externalities are omnipresent within the business environment, influence strategic management decisions, and affect the corporate performance. Particularly relationship networks of corporations have proved increasingly significant for institutions adapting to their changing environment. Although the vital significance of networks is generally acknowledged in management research and their fingerprints are ubiquitous, an implicit and underdeveloped treatment dominates the financial theory and the management practice. Linearly approximating or simply ignoring the distinctive nonlinear properties of networks, contemporary corporate finance literature for the most part fails to internalize the nonlinear network externalities from a complex systems perspective. This paper investigates the effects of an internalization of network growth and network resilience on corporate financial decisions in a value-based decision-making framework. In a first step, the nature of the network phenomenon is outlined from a complex systems perspective. Based on this framework, a research approach to the analysis of network growth and network resilience is formulated with structural and locational network methods complemented with dynamic network tools. In the main part of the paper, the graph theoretical approach is applied to illustrative case studies. In order to outline the potential of network research for corporate financial management, the network results are compared to conventional results. In essence, the assessment of the case studies reveals that the nonlinearity of networks is vitally influencing the risk and the value of corporations. Consequently, according to shareholder value principles, managers have to be aware of the implications of network externalities and should incorporate them in their managerial decision framework. Particularly the explicit investigation of vital accounting data, such as revenues, investments, and provisions, for nonlinear network interactions helps to explain the observed deviations between conventional linear heuristics and the complex real-world development. Therefore, the proposed internalization of the network externalities with the graph theory establishes a link between network analysis, corporate finance, and strategic business development. Furthermore, it emphasizes the necessity for financial research on the design of optimal network management strategies and the benefits of a general diffusion of the underlying complex systems principles in management.