Creative Destruction and the Perpetual Growth Assumption

In determining terminal value in a discounted cash flow (DCF) valuation, it is usually assumed that a mature company will grow at a constant rate in perpetuity. The impact of creative destruction and disruptive innovation interrupts and reverses historical growth patterns. If to the extent that the assumption of constant perpetual growth is invalid, the commonly used growth model in DCF analyses will overstate terminal value and cause overvaluations.

The perpetual growth concept needs to be reexamined. Companies, like people, have life spans. Valuators should recognize the risks of corporate decline and corporate mortality and make corresponding appropriate adjustments in their valuations.

It is necessary to develop appropriate premiums for mortality risks that can be applied for corporate valuations. Studies of corporate decline and mortality should focus on companies that suffer material declines because of poor performance or whose existence terminates. The studies need to analyze the data by industry and should measure the effect of size on mortality, considering such variables as revenues, gross margin, number of employees, tangible assets, and R&D expenditures.