microeconomics of achieving and sustaining supernormal returns- Information Theoretic Approach Revised Nov 28, 2005

This paper develops a set of management and production criteria needed to be used in order to maximize profits and shareholder values. If these criteria are achieved, the firm may achieve and sustain “supernormal” profits and revenue growth. The criteria developed here are all related to the stream of information value from the market, and the velocity of the resulting flow of information through the marketing, development, production and distribution processes. These streams are constructed in terms of their “Shannon information velocity” which provides a new way to derive the set of variables that effect (and maximize) the shareholder value. Rather than equating demand and supply at each point in time, the decision criteria is based on the Information Theoretic rate of market observations, and comparing it to the thermodynamic-analogue rate at which the firm reduces its costs per product manufactured, and the rate at which the products and services it offers respond to market changes. In addition, the paper derives the requisite valuation procedures for product and offering creation and destruction. To fulfill their role in maximizing shareholder value, management’s decision rule is based on analyzing the possible reduction of the internal process Boltzmann entropy and increase of external Shannon entropy of each potential investment and process at a certain time interval. The rule of maximizing Information Velocity leads to the most cost-effective investment in time and money and market responsiveness. With the above derivation, it is shown that the shareholder value of all business processes are driven by the rate at which the information is generated by the market is matched by the responsive acceleration of information within the business processes. Empirical examples are provided which confirm that superior Information Velocity in all processes achieves and sustains supernormal returns.