Scribd Logo
Upload

Welcome to Scribd!

  • Theory of Corp Fin - Historical

    Uploaded by

    Mila Rocha
    6 views12 pages
    Talking about the evolution of finance.

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document
    Talking about the evolution of finance.

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    6 views12 pages

    Theory of Corp Fin - Historical

    Uploaded by

    Mila Rocha
    Talking about the evolution of finance.

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    of 12
    ‘The Theory of Corporate Finance: A Historical Overview ‘Citfoed W. Smith, Je 1 INTRODUCTION My purpose is to provide a brief review of the development of the modern theory of corporate finance a a general background forthe articles included inthis book. The finance literature through the easly 1950s consisted in large part of ad hoc theories and institucional deta, bu litle systematic analysis. For example, Dewing (1919: 1953), the major eorpaate finance textbook for generations, describes the birth of a corpo- ration and follows it through various policy decisions to its death (bankruptcy). Cor- porate financial theory prior 1 the 1950s was fide with logical inconsistencies and as almost totally prescriptive, that is, normatively oriented, The majoc concerns of the field were optimal investment, financing, and dividend policies, but litle consid craton was given tothe effects of individual incentives, oto the nature of equilibrium in financial markets, ‘The theory of financial markets in the 1950 was inthe same undeveloped state as the theory of corporate finance. Portfolio theory was in its infancy, and the pricing and other implications of egoiirum in financial markets were largely ignored. The leading book on security analysis, GraharvDods (3981), describes how to “pick win- ners" by analyzing te firm's assets, earings, dividends, and so on. Questions suclt 35 how those Winners are formed into portfolios, or how such analysis could consis tently succeed given the widespread competition among investors for undervalued se curities were not usually addressed. Inthe 1950s, Fundamental changes in finance began to occur. The analytical meth= ‘ods and echniqus traditional to economics began to be applied to problems in finance, and the resulting transformation bas been significant, This evolution was accompanied by a change in the focus ofthe literature from normative questions such as “What should investment, financing, or dividend policies be?" to positive theories addressing questions such as "What are the effects of alternate investment, financing, or dividend policies on the value of the fien?” This shift in research emphasis was necessary 10 provide the scientific basis forthe formation and analysis of corporate policy decisions. The logical structure of decision making implies that beter answers to normative {questions a likely to occur when decision makers have a richer set of postive theories that provide a beter undersuning of the consequences oftheir choices. This impor: clare Potestr of Finance, Wiliam E, Simon Graduate Sohoo of Business Adminisation Ur 4 THETHEORY OF CORPORATE FINANCE: A HISTORICAL OVERVIEW ‘ant relation between normative and postive theories often goes unrecognized. Pur- poseful decisions cannot be made without the explicit or implicit use of positive the- fries. Managers cannot decide what action to take and expect to meet their objective if they have 10 idea about how alternative actions affect the desired outcome—and that is what is meant by a positive theory." For example, to choose among alternative financial structures, a manager wants to know how the choices affect expected net ‘ash flows, the level of risk, and therefore the effect on firm value. Using incorrect, Positive theories leads to decisions that have unexpected and undesirable outcomes. 2. FUNDAMENTAL BUILDING BLOCKS ‘The years since 1950 have witnessed the formulation of the major building blocks of the modern theory of financial economies: Efficient Markets Theory—analysis ofthe behavior of price changes through time in speculative markets. Portfolio Theory—analysis of optimal security selection procedures for an inves- tor's portfolio of securities. Capital Asset Pricing Theory—analysis of the determinants of asset prices under conditions of uncertainty Option Pricing Theory—analysis of the determinants of the prices of contingent

    You might also like