Corporate Financial Policy: What Really Matters?

Corporate Financial Policy:
What Really Matters?
Harry DeAngelo*
March 1, 2021
Abstract
Reliable access to funding, as in Myers and Majluf (1984), is what really matters, but there are nontrivial
indeterminacies in how such access is arranged and in the debt, cash-balance, and payout components of
financial policy. These inferences are from a corporate “twins” comparison study of the financial policies
of Henry Ford at Ford Motor Co. and Alfred P. Sloan, Jr. at General Motors Corp. The documented
testimony of Ford and Sloan indicates that both focused on funding their business, with debt as a funding
tool, not an element of an optimized leverage ratio. Their financial policies differ in five important respects,
including (i) the use of debt versus large cash balances to meet funding needs and (ii) a commitment to
paying large dividends versus a strong aversion to payouts. The data also point to the importance of the
inability of managers to identify optimal policies with reliable precision.
Key words: capital structure; payout policy; cash balances; corporate financial policy
JEL classification: G32, G35
Contact: hdeangelo@marshall.usc.edu
*Kenneth King Stonier Chair Emeritus, Marshall School of Business, University of Southern California. I
thank David Denis, Eugene Fama, Andrei Gonçalves, Arthur Korteweg, Kevin Murphy, Stewart Myers,
Christopher Parsons, Rodney Ramcharan, Jay Ritter, Richard Roll, René Stulz, and Sheridan Titman for
helpful comments on this paper.
Electronic copy available at: https://ssrn.com/abstract=3800092

Corporate Financial Policy:
What Really Matters?
1. Introduction
Economic fundamentals determine uniquely optimal financing decisions in the capital structure models
that dominate the post-Modigliani and Miller (1958, MM) literature. Most obviously, the nature of a firm’s
earnings and investments determine its uniquely optimal leverage ratio in static (one-shot) tax/distress-cost
tradeoff models of the Robichek and Myers (1966) class and the time path of such ratios in dynamic
extensions thereof. And while firms in Myers and Majluf (1984) and Myers (1984) do not have leverage
targets, the sequence of a firm’s cash-balance levels, debt issuances, and equity issuances – and therefore
also the time path of its chosen leverage ratio – are uniquely determined by its earnings realizations and
investment outlays. A second (polar-opposite) view is advanced in the incomplete-market and tax-inclusive
extensions of MM by Stiglitz (1969), Fama (1978), and Miller (1977) in which cross-firm differences in
leverage do not reflect differences in economic fundamentals because financial policy is irrelevant.
A third perspective is that debt, payout, and cash-balance policies viewed as a collective whole matter
because of economic fundamentals, yet there are indeterminacies in one or more of these financial policy
components. By indeterminacies, I mean decisions that are not pinned down uniquely by the economic
fundamentals of a firm’s line of business. I do not mean to restrict attention to decisions that are literally
irrelevant, although literal irrelevance is a special case of indeterminacy under this definition. In any case,
there are no indeterminacies (in the sense that I discuss here) in the leading models of capital structure that
dominate the empirical literature and textbooks.
Indeterminacies in aspects of capital structure and other major components of financial policy arise
most plausibly in real-world settings because some feasible choices are close enough to one another in
actual economic impact that managers cannot detect with reliable precision any meaningful differences in
them. With managerial knowledge limited in this way, there is no longer a unique mapping from underlying
fundamentals to specific financing decisions. Instead, financing decisions reflect managerial judgment in
the face of substantial uncertainty about the best financial policies for their firms.

This third perspective on financial policy draws strong support from this paper’s evidence, which also
yields numerous other useful lessons about the nature of an empirically credible theory of financial policy.
I discuss those lessons in the final two sections of the paper after presenting the evidence.
The evidence comes from a corporate “twins” comparison study of the financial policies of two of the
most important firms of the modern industrial era while run contemporaneously by two of the most
innovative and influential managers in the history of commerce: Henry Ford of Ford Motor Co. (FMC) and
Alfred P. Sloan, Jr. of General Motors Corp. (GM). Steve Jobs is the best modern analog of Ford, as they
were both world-changing innovators and major business celebrities. Bill Gates and Warren Buffett are the
best modern analogs of Sloan because of the widespread respect they command for their business wisdom.
Sloan was, and remains, highly influential for the principles he delineated for managing large firms, with
Gates indicating that Sloan’s memoir, “My Years at General Motors,” is “probably the best book to read if
you want to read only one book about business.”
The evidence presented here concerns the principles Ford and Sloan described as governing their
financial policies at FMC and GM. This feature of the evidence is important because differences in
governing principles cannot be dismissed on grounds that different firm-specific shocks may have led two
otherwise similar firms to make markedly different financial decisions. In any case, the actual decisions of
FMC and GM conform to the principles articulated by Ford and Sloan.
The data indicate that reliable access to funding, as in Myers and Majluf (1984), is what really matters
for the financial policies of Ford and Sloan. However, there are important differences in how Ford and
Sloan addressed the funding issue, reflecting (i) marked differences in the debt, cash-balance, and equity-
payout components of the overall financial policies of FMC and GM and (ii) important complementarities
in how these main components of financial policies were chosen to fit together. Given the strong similarities
in the underlying economic fundamentals of FMC and GM, the sharp differences observed in funding
access and in debt, cash, and payout policies under Ford and Sloan indicate that these components of overall
financial policy were not determined solely by the underlying fundamentals of the business.
Ford and Sloan both viewed debt as a funding tool to meet the capital needs of the business, with neither

mentioning a target leverage ratio, tax benefits of debt, or any reason why their firms might want to have
debt permanently in the capital structure. Ford was reluctant to take on debt, but he had FMC maintain
untapped lines of credit in case outside funds were needed. Ford did not like the idea of closely held FMC
paying dividends, which helped FMC maintain large cash balances that could also be used to meet funding
needs. Ford, in sum, provided for funding access at FMC through a fortress-balance-sheet strategy, with
high cash balances fostered by an aversion to equity payouts, virtually no use of debt, and large unused
credit lines that provided the option to borrow in a funding emergency.
Although Sloan did not like debt, he viewed borrowing as more acceptable than Ford did. He also
thought of debt as a funding tool rather than as an element of an optimized (or target) debt-equity ratio.
Sloan believed that GM should borrow only if internal funds were inadequate to cover funding needs, with
generous dividend payments and investment outlays both being important funding needs. GM under Sloan
had public shareholders, but was controlled by E.I. du Pont de Nemours and Co. (DuPont), which held a
large minority stake. Capital access during cash squeezes came from operating flexibility, with Sloan
willing and able to cut labor expenses sharply in the face of a sales decline. This operating flexibility
benefit was enormous, as worker layoffs in the early 1930s enabled GM to remain profitable and pay
dividends throughout the Great Depression, despite a stunningly large 70% fall in vehicle sales.
The data also reveal interdependencies among the endogenous components of financial policy, with the
specific chosen component features differing because of different objectives of the controlling shareholders.
Henry Ford was more strongly disposed to avoid debt than Sloan was because he did not want bankers to
threaten his control of FMC. He accordingly retained cash in lieu of paying dividends to build large cash
balances at FMC, which meant that borrowing could be avoided except in funding emergencies. GM’s
controlling shareholder (DuPont) wanted dividends and so, presumably, did its public shareholders.
DuPont was necessarily more tolerant of debt at GM because it viewed GM’s dividends as a way of funding
its own operations, which enabled DuPont to avoid debt during virtually the entire time Sloan ran GM.
In sum, while Ford and Sloan were concerned with reliable access to funding, their financial policies
were not uniquely determined by the economic fundamentals of the auto business. Instead, they had ample

degrees of freedom to tailor (jointly) the constituent elements of financial policy to fit the objectives of each
firm’s controlling shareholder. These differences were not mistakes that undermined the survival of either
FMC or GM, as both continued to thrive long after the tenures of Ford and Sloan ended.
2. Henry Ford and Alfred P. Sloan, Jr. and their firms: Background information
Under the leadership of Ford and Sloan, FMC and GM were, of course, highly successful producers of
automobiles. GM was arguably the most important firm in the US economy for well over half of the 20th
century, and inarguably the most important US firm for most of Sloan’s tenure. As one indication of GM’s
importance, consider the famous statement made to the US Senate by “Engine Charlie” Wilson, who served
as GM’s President while Sloan was Chairman and who later served as Eisenhower’s Secretary of Defense:
“[F]or years, I thought what was good for our country was good for General Motors and vice versa. The
difference did not exist. Our company is too big. It goes with the welfare of the country.”
In 1956, the first year of FMC’s public stock ownership and Sloan’s last year at GM, FMC ranked #3
in the Fortune 500, while GM ranked #1. [Exxon was #2 in that sales-based ranking.] GM and FMC both
faced serious trouble in the Great Recession and GM’s shareholders were wiped out in the firm’s 2009
bankruptcy. Those difficulties post-date the tenures of Sloan and Ford by many decades, but the legacy of
Sloan’s financial policies nonetheless played a role in GM’s 2009 collapse (see section 4.4).
Henry Ford and Alfred P. Sloan, Jr. are two of the most innovative and influential managers in the
history of commerce. Ford was the founder of FMC and is credited with (i) major innovations in mass-
production manufacturing techniques, (ii) production of the first affordable automobile, and (iii) initiating
the “$5 work day,” which represented a huge leap in pay for rank-and-file workers.
Sloan served as President (and later as Chairman) of GM and is credited with (i) numerous innovations
in automobile production and marketing, (ii) inventing the multi-division form of corporate organization,
and (iii) bringing financial discipline to GM and turning the firm into a profit-generating juggernaut.
Henry Ford ran FMC from its incorporation in 1903 until well into the 1930s, although his son, Edsel,
became President of the firm in 1918. He also ran FMC briefly in the 1940s after Edsel’s death. FMC was

closely held until it went public in 1956, nine years after Henry Ford died. The IPO, the largest in US
history up to that point, raised no funds for FMC. It was a liquidity event that enabled the Ford Foundation
to sell FMC shares and diversify its portfolio.
Sloan was appointed President of GM in 1923, about 14 years after GM was founded by Billy Durant,
and he retired in 1956. Sloan was appointed President after DuPont interests had taken control of GM
following multiple episodes of financial trouble under Durant’s leadership. During Sloan’s entire time as
leader of GM, DuPont controlled the firm through its holding of a large minority stake. GM also had a
large number of public shareholders.
Throughout the paper, I refer to Sloan’s financial policies, but that is a bit misleading because he was
advised by John Jakob Raskob and Raskob’s protegé, Donaldson Brown, both of whom held the Treasurer
position at DuPont and then at GM. When Pierre duPont announced that DuPont was buying a large stake
in GM, he told the audience that, as (business historian) Farber (2013, p. 142) paraphrases, “DuPont would
bring its proven record of financial expertise to the General Motors Corporation. A more powerful GM
finance committee was to be formed, ruled by DuPont Company officials and headed by John J. Raskob.”
Raskob and Brown are both historically important figures in the development of financial management
practices, especially the DuPont system, whose ROI analysis became a foundational element of the finance
education of generations of business students. Raskob thought innovatively about finance and was famous
in his own right as a wealthy investor. It was his idea for DuPont to use its massive cash pile (earned from
munition sales in World War I) to rescue GM from financial distress and, ultimately, to take control of GM.
Among Raskob’s many finance-related accomplishments is the creation of General Motors Acceptance
Corporation (GMAC), GM’s captive-finance subsidiary, making him a pioneer in the practice of providing
banking services to customers to foster purchases of consumer durables.
3. Henry Ford on corporate financial policy
Henry Ford detailed the principles guiding his financing decisions in his 1922 book titled “My Life and
Work.” Table 1 documents ten passages (quoted verbatim) from the book, with key phrases italicized for

emphasis. The passages are indexed from F1 to F10, with F1-F6 dealing with issues of funding access and
F7-F10 dealing with payout policy. I reproduce F1 and F2 in this section of the paper because they make
points that are particularly important for this study. I discuss F3-F10 in this section, but leave it to the
reader to examine them directly in Table 1.
Ford’s principle F1 indicates that his focus was on having FMC maintain a fortress balance sheet, with
large cash balances, lines of credit that gave FMC the option to borrow very large amounts of cash in case
of an emergency need for funds, and no debt aside from that taken on in an emergency:
F1. “It has been our policy always to keep on hand a large amount of cash – the cash
balance in recent years has usually been in excess of fifty million dollars. This is deposited
in banks all over the country, we do not borrow but we have established lines of credit, so
that if we so cared we might raise a very large amount of money by bank borrowing. But
keeping the cash reserve makes borrowing unnecessary – our provision is only to be
prepared to meet an emergency.”
Ford did not believe that debt should be a permanent component of the capital structure. His principle
F2 indicates that one should borrow to meet a specific funding need and have a plan to pay it off.
F2. “The thing is to keep money and borrowing and finance generally in their proper place,
and in order to do that one has to consider exactly for what the money is needed and how it
is going to be paid off.”
F2 describes a purely transitory use of debt capital to meet a funding need, followed by eventual full
repayment. The intuitive analog is how a prudent consumer uses a credit card – use the card when a need
for funds arises, then repay the balance to restore borrowing capacity.
Principles F3 and F4 indicate that Ford thought it was acceptable for FMC to borrow to help the
business grow, but not to cover up earnings shortfalls from mismanagement, while F5 and F6 indicate that
he sought to limit the amount of debt because of the risk of losing control of FMC to creditors.
Ford believed that FMC’s dividend payments should be kept low and said that he would abolish
dividends before cutting wages (F7 and F8). This aversion to dividends, of course, helped Ford maintain
the high cash balances (F1) that were central to his funding strategy. He also felt that shares of FMC should
be held only by people active in the business, and he explicitly eschewed the view of a business as a money-
making machine, which means he rejected a centerpiece of modern finance theory (F9). He similarly

disavowed the principle – also central to modern finance theory – that optimal payout policies entail full
payout (in an overall present value sense) of the free-cash-flow stream (F10).
While the comparison with Sloan’s policies (section 4) indicates material indeterminacies in financial
policy, a look at Ford’s set of financial policies points to strong interdependencies among the components
that he selected. Most notably, Ford clearly cared greatly about keeping control of FMC. He accordingly
sought to avoid exposure to the risk of losing control to creditors (F5 and F6) and his decision to keep the
equity closely held, of course, meant he would not lose control directly. The decision to keep FMC closely
held also meant he would not face pressure for dividend payments from public shareholders. That, in turn,
allowed FMC to retain more cash and rely more on its cash hoard for funding. In short, these elements of
financial policy fit together well with the objectives of being able to fund the business adequately without
running the risk of losing control. The implication: Indeterminacy of overall financial policy viewed as a
package does not rule out interdependencies among the component elements of that package.
That same point applies to Sloan’s policies. His strong commitment to make substantial dividend
payments (section 4.2) reflects an interdependence with GM’s equity ownership, with its controlling
shareholder (DuPont) and also, presumably, its public shareholders interested in receiving large ongoing
payouts. As Farber (2013, p. 142) reports, Pierre duPont justified DuPont’s investment in GM in part on
the fact that DuPont was planning a large-scale diversification program and that GM “would supply the
Company with big cash dividends during a period when the new product divisions might well need capital
subsidies, if only in the short to mid-term.” I would note in passing that DuPont’s concern with GM’s
dividend policy is consistent with the main finding here about FMC and GM, namely that access to funding
is what really matters when managers select financial policies.
Let me close this section by briefly confirming the relationship between the stated policies of Ford and
Sloan and the actual policies of their firms. From 1903 to 1915, FMC paid dividends (Nevins (1954,
appendix 8)). When FMC stopped paying dividends, the Dodge Brothers, who were minority shareholders,
sued to compel payouts and, in a famous legal decision, FMC was ordered to pay a nontrivial dividend. In
late 1919, shortly after that decision, Ford bought out all non-family shareholders in FMC (Nevins (1954,

chapter 22)). Although FMC was privately held, Moody’s reports basic financial information on FMC
beginning in the early 1920s and continuing through until Ford’s death in 1947 and beyond. The 1947
Moody’s entry states that the 1919 payout was the last known dividend by FMC during Ford’s lifetime. I
inspected all of the Moody’s reports for FMC from 1923 onward. Those reports show occasional trace
amounts of debt outstanding at FMC and very large cash balances.
The bottom line is that FMC under Henry Ford actually followed the fortress balance sheet and
dividend-avoidance policies that Ford described in his memoirs.
A similar bottom line applies to Sloan. I inspected all of GM’s annual reports and constructed a
consolidated balance sheet that includes debt issued by GMAC. Leverage plots for GM show wide time-
series variation; see DeAngelo and Roll (2015, figure 1). The balance-sheet data conform fully to Sloan’s
principle about issuing debt when needed for funding, and the annual reports confirm generous dividends.
These points are quite evident in the debt and dividend behavior in Table 3 below; see section 4.3.
4. Alfred P. Sloan, Jr. on corporate financial policy
Table 2 documents Sloan’s view of financial policy in principles S1-S10, which are quoted verbatim
(with italics added for emphasis) from his memoir, “My Years With General Motors,” and from two
interviews that were published in the New York Times: “General Motors’ Financial Policies” (June 13,
1927) and “Sloan Explains Dividend Policy” (September 12, 1935). S1-S6 deal with debt and related
funding issues, while S7-S10 deal with payout policy (and also have funding ramifications). I reproduce
S1, S2, and S10 in this section of the paper because they make points that are especially important. I also
discuss S3-S9 in this section, but leave it to the reader to examine them directly in Table 2.
Sloan’s principle S1 indicates it is difficult for managers to identify the specific features of an optimal
policy, thus leaving nontrivial scope for judgment to play an important role in the choice among a set of
policies that seem reasonable to the decision maker.
S1. “The strategic question in industrial finance, assuming you have something to work
with in the way of a going business, is how to optimize its elements. The latitude for
opinion, or subjective judgment here, is wide.”

This principle is important because it points to a plausible source of indeterminacy in the choice of
financial policy. If managers are operating with significantly limited knowledge about the determinants of
financial policy, it makes sense that there would be multiple different policy choices that are all roughly
equivalent in their eyes.
4.1 Debt and funding
In S2, Sloan indicates that, although he did not personally like debt, he did not have a policy against
borrowing. Instead, the periods in which GM did not borrow were simply the result of the firm not needing
funding. Sloan thus did not think that GM should keep some amount of debt in its capital structure on a
permanent basis, i.e., the notion of a positive target leverage ratio is antithetical to his view of debt.
S2. “…from 1921 to 1946 the corporation avoided long-term debt. I myself had feelings
against debt, perhaps because of what I had seen of it in my experience. And yet I cannot
say that we had an antidebt policy in that period. The facts show that we were generally
able to do without it…..In other words, we paid off and grew, without debt, except for bank
loans, during short periods in the 1920s. The 1930s being a time of consolidation, the
question of debt did not arise. During the war years, we arranged for a bank credit of $1
billion, through the government, to finance receivables and inventories, but borrowings
under those arrangements were limited.”
S2 understates the usage of debt by GM during the 1920s. In those days, GM did not consolidate the
debt of its subsidiaries onto the parent’s balance sheet. So, even when its captive-financing subsidiary,
GMAC, had nontrivial debt outstanding, it entered the parent’s balance sheet only as an asset (equity
investment in GMAC). I have created a consolidated balance sheet that moves GMAC’s assets to the left-
hand side of the parent’s balance sheet and its debt to the right-hand side. The consolidated balance sheet
shows that, during the 1920s, GM actually had a book leverage ratio (debt/total assets) in the 0.100 to 0.200
range. This consolidated treatment makes it clear that Sloan was clearly more tolerant of borrowing than
Ford. At the same time, it is clear that GM was not a heavy user of debt in Sloan’s early years as President.
I would add that DuPont, which controlled GM during Sloan’s entire time running the firm, was an
unlevered firm for virtually the entire time that Sloan was in charge of GM. Clearly, neither GM nor DuPont
was managed with the idea that it was important to have debt in the capital structure.
In any case, one should not let these details cloud the key message of S2, which is that Sloan viewed

debt as a tool to meet GM’s funding needs, not as a variable to be adjusted to optimize the debt-equity mix.
In S3-S6, Sloan indicates his preference for an approximate pecking-order approach to funding
decisions. Internal financing is preferred if the growth of the firm is slow enough to accommodate funding
from the retention of earnings (S3). When internal funds are inadequate to cover funding needs, external
capital must be obtained from outside sources (S4) and the preferable way is through borrowing (S5). There
is a limit to how much borrowing makes sense, and so issuing common stock may be in order avoid issuing
unduly risky debt (S5) and/or having too much debt relative to equity (S6).
I use the “approximate pecking-order” label to describe S3-S6 for two reasons. First, these principles
contain only a vague suggestion about the “break” points at which it makes sense for a firm to switch from
funding through cash balances to issuing debt, and from issuing debt to issuing new equity. Second, in S3-
S6, Sloan clearly does not mean to say new investment should be financed internally as long as the firm
has enough cash to cover the investment outlay.
The reason, as S7-S10 make clear, is that he treated the need to pay generous dividends as a prime
policy objective. Myers and Majluf’s (1984) strict pecking-order model treats dividends as exogenous, as
does Myers’ (1984) modified pecking-order model based on the idea that dividends are “sticky.” Neither
fits what Sloan says about dividends, which is that they are of first-order importance, and neither fits GM’s
actual policies during its massive post-World War II expansion, as section 4.3 documents.
4.2 A strong commitment to pay dividends
Sloan’s commitment to paying substantial dividends stands in sharp contrast to Ford’s policy of limiting
payouts, and thus made it more difficult for GM (than for FMC) to maintain high ongoing cash balances to
cover emergency funding needs, as was an important element of the way Ford managed FMC.
In remarkable anticipation of one of the most important implications of modern finance theory, Sloan’s
S9 articulates a strong commitment to distributing the largest possible share of earnings consistent with the
needs of the business. In the language of modern theory, S9 says that Sloan was committed to the payout
(over the long-term) of the full value of the free-cash-flow stream generated by the business. [For what it’s
worth, it is doubtful that Sloan knew he was effectively endorsing value-maximization as GM’s objective,
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as he also thought shareholders’ interests should be subordinated to what is best for the business.]
In setting dividend policy, Sloan’s principle S10 indicates there is a difficult estimation problem of
gauging the need for investment funding going forward for an extended period:
S10. “…the problem of dividend policy is not always a simple one. A rate of dividend
when once declared carries with it the desirability of continuity. The declaration must
reflect not only the current condition of the business but there must be considered the future
trend, especially with respect to prospective earnings and possible capital needs. Under
conditions existing today, such an appraisal is difficult.”
This point repeats the theme in S1, and supports the general idea that managers have serious difficulties in
figuring out the precisely best way to address their firm’s financing problems.
4.3 GM’s post-WWII expansion: Funding, debt, and dividends
Toward the end of World War II, Sloan publicly forecasted a strong post-WWII boom in demand, a
position that ran strongly counter to a view widely held by economists, including noted Keynesian Alvin
Hansen whose AEA Presidential Address forecasted serious “secular stagnation” and called for massive
government post-war outlays (Farber (2002, pp. 236-237)). Sloan stuck by his guns and planned for and
implemented a major expansion in GM’s production capacity and, as we now know, he was absolutely right
about the coming boom in demand.
Table 3 documents the tight linkage among funding, debt, and dividends during GM’s large expansion
in the years after WWII. At the end of 1945, just a few months after WWII ended, GM was essentially
unlevered, with a book leverage (debt/assets) ratio of 0.001 (row 1). At the end of 1956, Sloan’s last year
with GM, the firm’s leverage ratio was 0.364 (row 1), reflecting an increase in debt from about $1 million
to more than $3.7 billion (row 9). In every year in Table 3, GM paid dividends that were a large fraction
of earnings (row 2), consistent with Sloan’s strong commitment to deliver cash to shareholders.
Table 3 shows that, over 1945-1956, capital expenditures totaled $4.4 billion (row 3), which is well
below the $7.0 billion in net income (row 4) and just slightly more than the $4.1 billion in dividends (row
6). GM could easily have funded its massive capital outlays internally, but needed to raise outside funds
because of the large dividend payouts it made in tandem with its investment outlays.
Note that well over half of the dividend payouts over 1945-1956 represent increases over the amount
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paid out in 1945 (compare rows 6 and 7 of Table 3, last column). GM’s post-war need to raise capital
therefore does not just reflect “sticky” dividends. It reflects proactive decisions to increase the payouts to
shareholders contemporaneously with the large capital outlays for its expansion program.
In raising the needed outside funds, GM relied overwhelmingly on borrowing, with only one public
sale of stock in 1955 (row 10 of Table 3), just as Sloan’s principles S5 and S6 stipulate the firm should do
when raising outside funds. In sum, over 1945-1956, GM’s leverage increased sharply as it raised a large
amount of debt capital to fund a massive post-WWII expansion program while delivering large and
substantially increased payouts to its shareholders.
Sloan (1963, p. 211) is unequivocal about how GM’s funding needs for both the expansion program
and dividends drove its external financing in the post-war period: “Our stock and debenture issues made it
possible for us to carry out our expansion program and at the same time continue our policy of paying
liberal dividends.”
Bottom line, under Sloan, funding needs drove the post-war increase in GM’s leverage, with funding
needs defined to include both investment outlays and equity payouts.
4.4 Operating flexibility: Large-scale worker layoffs
Pelfrey (2006, p. 260-261), a former GM executive, describes the substantial operating flexibility that
GM had until the late 1930s when – understandably, as the reader will soon see – labor unrest forced GM
to recognize the UAW. The genesis of this flexibility was Donaldson Brown’s design (in the early 1920s)
of a financial reporting and production-management system that Pelfrey describes as providing “optimum
production capacity utilization needed to guarantee an acceptable profit and return on investment in both
up cycles and down cycles.” The result of this system was that GM “would not be caught with excess
inventory and would remain profitable during even the worst downturns.” The system used frequently
updated sales forecasts to adjust monthly production quotas, thus forcing production workers and plant
managers to deal with substantial employment volatility – layoffs when times were slow, and overtime
production pressures in boom times.
Thus, in the pre-World War II period, Sloan had an incredibly effective way of using operating
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flexibility to address funding needs when GM was squeezed for cash: Lay off many workers and cut wage
expenses radically. Such layoffs enabled GM to remain profitable and to pay dividends throughout the
Great Depression, despite vehicle production falling 70% from around 1.9 million units (trucks and cars)
in 1928 to around 563,000 units in 1932. Over the same period, GM reduced its wage bill by 65% (from
$390 million to $143 million) and its number of employees by 50% (from around 233,000 to around
116,000), with the smaller percentage reduction in head count reflecting a switch to part-time work for
some employees. GM reduced total dividend payments from $157 million in 1929 to $54 million in 1932
(a 66% decline), with the latter distribution made possible by the $247 million dollar reduction in wage
outlays over the same period.
Sloan’s ability to avoid large cash outlays for wages through massive (and rapid) layoffs was obviously
an extremely powerful financial management tool. However, use of this tool set in motion a chain of events
that played out over the remainder of the 20th century and that ultimately resulted in GM’s 2009 bankruptcy.
These events include (1) massive labor unrest in the 1930s, with the 1936 “sit-down” strike at GM’s Fisher
Body Plant No. 1 in Flint, Michigan being a catalytic event in the national unionization movement and an
event that specifically resulted in GM recognizing the UAW in 1937; (2) a delay because of WWII in the
UAW’s ability to exercise its newly obtained collective-bargaining muscle; (3) post-WWII strikes that led
to GM caving to significant union demands in 1950’s famous “Treaty of Detroit”; and (4) many subsequent
years of adversarial relations between GM and the UAW, with repeated attempts by GM’s management to
keep production flowing by providing greater job security for its unionized workforce. [Farber (2003)
discusses (1), (2), and (3) at length, while most readers of this paper are no doubt aware of (4).]
This process of concessions to workers eliminated the operating flexibility that had enabled Sloan to
keep GM operating profitably through the Great Depression, despite a 70% collapse in vehicle sales. In
the Great Recession, GM’s vehicle sales fell by a much smaller, although still substantial, 20%. That
decline – coming as it did amid a capital market frozen by the financial crisis – was enough to force GM to
seek a government bailout, which of course resulted in bankruptcy and shareholders being wiped out.
The latter outcome is materially misleading in an important sense. Yes, GM’s shareholders lost
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everything in bankruptcy. But GM had continued to be run with Sloan’s commitments to large ongoing
payouts to shareholders. So, while the buy-and-hold rate of return for shares held from GM’s founding
through the 2009 bankruptcy is -100%, shareholders received many billions of dollars in distributions over
the decades before the bankruptcy, and therefore did quite well financially. They have Sloan’s (and GM’s
continued) commitment to large equity payouts to thank for that.
In any case, there is no plausible argument that this full sequence of events could have been anticipated
when Sloan used massive layoffs to help GM navigate profitably through the Great Depression. It’s a great
example of path-dependency in financial policy, with an “unknown unknown” at the time of decision that
turned out to be very important many years later. Sloan’s principle S10 emphasizes the substantial
uncertainty that is central to the decision landscape with financial policies. There is no way that the models
of financial policy that we currently have deal effectively with “unknown unknowns” of the type that
eventually led to GM’s collapse. However, such uncertainties clearly exist and need to be considered when
assessing the policies that managers adopt to address the problem of arranging reliable access to funding.
5. What we learn from comparing the financial policies of Ford and Sloan
“Mert was right!” That was Dick Roll’s instinctive reaction in 2011 when he first saw the substantial
time-series volatility in the long-run leverage plots that are now in the appendix to DeAngelo and Roll
(2015). His reaction invoking the view that Merton Miller championed for so long makes perfect sense,
and it has nagged at me for nine years. Because it would seem to take an implausibly large amount of time-
series variation in target leverage ratios to explain the instability in actual leverage ratios, the data make
one doubt that optimizing the debt-equity mix is an important managerial concern. While the plots clearly
show that managers of nonfinancial firms tend strongly to avoid high leverage, it is entirely possible that
leverage differences do not matter (and thus are not linked to economic fundamentals) over low-to-
moderate leverage ratios. Other signs that suggest that managers do not worry much, if at all, about
optimizing the debt-equity mix include weak mean reversion in leverage (Yin and Ritter (2019)) and
Korteweg’s (2010) estimates of a relatively flat function linking firm value to leverage.
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For two reasons, a corporate “twins” comparison of Ford and Sloan offers a useful natural experiment
to gauge what features of financial policy really matter. First, FMC and GM had underlying economic
fundamentals that arguably are virtually identical, and inarguably are quite similar. So, if their financial
policies are markedly different, then we can infer that those policies are not uniquely determined by the
features of a firm’s line of business. If they are quite similar in some dimensions, then we can reasonably
infer that fundamentals determine those aspects of financial policy at FMC and GM. In the literature, the
closest precedent for this approach to inference is the Kroger-Safeway study by Denis (1994).
Second, the fact that Ford and Sloan were so prominent in their day means that the public record
includes their unequivocal testimony about the financial policies they followed in running FMC and GM.
We can accordingly draw inferences about the similarities and differences in their financial policies without
the worry that we are using noisy data that include the difficult-to-remove effects of firm-specific shocks.
I would add that Ford and Sloan and their firms have played such an important role in the modern
industrial era that knowledge of how they approached financial management is of inherent importance to
the study of corporate finance. Indeed, any theory of financial policy that cannot explain the commonalities
of, and differences in, their financial practices has serious empirical shortcomings.
5.1 What the data show: Key findings
The financial policies of Ford and Sloan share a common focus on providing reliable access to funding
for their firms. Both viewed debt as a vehicle for meeting their firms’ need for funds. Neither mentioned
having a target leverage ratio or a concern with capturing tax benefits of debt. Neither mentioned any
reason that their firms should have debt permanently in the capital structure. Neither liked the idea of
borrowing, but Sloan was clearly more tolerant of debt.
The financial policies of Ford and Sloan differ markedly in five important dimensions: (i) how funding
access is arranged, (ii) their willingness to use debt, (iii) their emphasis on holding large cash balances
versus using operating flexibility to free up cash, (iv) a strong commitment versus strong aversion to paying
substantial dividends, and (v) reliance on public versus private equity capital.
Given that, for many years, Ford and Sloan simultaneously ran large US manufacturers of automobiles,
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these differences in their financial policies are indicative of indeterminacies in the capital-structure, equity-
payout, and cash-balance components of financial policy when each component is viewed in isolation.
5.2 What the data show: Interdependencies among endogenous elements of financial policy
The data also indicate interdependencies among the components of financial policy when they are
viewed holistically. For example, Ford (and his wife and son) owned all of the equity of FMC, and Ford
was unequivocal about his desire to maintain control of the firm and to avoid interference from bankers.
The elements of FMC’s financial policies were chosen accordingly. By choosing massive cash retention
in lieu of large dividend payouts, Ford could build large cash balances within FMC, which enabled him to
avoid borrowing except in emergencies.
GM’s controlling shareholder, DuPont, was not as focused on maintaining a tight grip on control of
GM and instead was concerned with receiving large cash dividends to meet its own funding needs. With
large amounts of cash flowing out to shareholders on an ongoing basis, Sloan was necessarily more tolerant
than Ford of using debt to meet the funding needs of GM’s business.
The data on interdependencies thus inform us about how the endogenous components of financial
policy were chosen to work together under Ford and Sloan. They were chosen differently at the two firms
because the controlling shareholders had different objectives: Henry Ford wanted especially tight control
of FMC, while DuPont wanted cash from GM to cover its own funding requirements.
I use the term interdependencies to describe these relationships because equity ownership and debt,
cash, and payout policies are all endogenous. One might be tempted to interpret equity-ownership structure
as an exogenous factor that determines the other three decisions, but that would not be appropriate because
all four are choice variables that are jointly determined. The interdependency findings are appropriately
viewed as informing us about how the chosen components of financial policy fit together in complementary
fashion under both Ford and Sloan.
I would note in particular that the existence and size of public shareholders’ stake in GM were an
endogenous by-product of DuPont’s decision to obtain dividends from GM to fund its own operations.
DuPont controlled GM’s board, and so it could have directed GM’s profits to buying up large amounts of
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publicly shares, just as it could have avoided taking on debt to fund GM’s post-war expansion plan. [Table
3 documents modest share repurchase activity by GM many years before repurchases became prevalent
among US firms.] But since DuPont wanted cash from GM, it simply had no choice except to adjust on
other margins. There is no escape from the sources-and-uses-of-funds condition. That condition is
ultimately why “interdependence” properly describes the endogenous relationships among equity
ownership and debt, cash, and equity payouts.
5.3 What about economic rents, agency costs, and taxes?
FMC and GM likely generated large economic rents under Ford and Sloan, and so one might conjecture
that their conservative use of debt reflects agency costs in which managers sacrifice shareholders’ interests
to give themselves an easier life. The equity holdings of both firms do not support that view. FMC was
closely held with Henry Ford running the firm and, as of 1919, owning 100% of the equity (with his wife
and son). That is the zero agency cost baseline of a 100% owner-manager. At GM, DuPont held a large
equity stake, controlled the board, and viewed the firm as a cash-generating machine, with a dividend policy
that delivered large ongoing payouts to DuPont. Thus, GM under Sloan had much in common with a
modern-day operating firm controlled by a private-equity investor. Moreover, GM under Sloan was not
averse to using debt aggressively. It did so to fund its massive post-WWII expansion. It used substantial
amounts of debt when there was a substantial funding need, and avoided debt when there was not.
These same equity-ownership incentives also suggest a need to take seriously the fact that neither Ford
nor Sloan mentioned taxes as a factor in setting financial policies. They were surely aware that taxes exist
and that taxes would vary with the amount of debt outstanding and cash balances. From 1920 to 1937, the
Federal corporate income tax rate (for nontrivial income levels) ranged between 10% and 15%, which is a
bit lower than today’s 21% rate. Perhaps Ford and Sloan viewed those tax rates as negligible, but this
interpretation seems questionable, as tax rates of 10% and higher do not seem like rounding error.
Consequently, the most reasonable interpretation I can see is that Ford and Sloan viewed issues about
funding per se and the other elements of financial policy that they discuss as clearly dominating any tax
effects. This interpretation seems plausible, given that sophisticated large-sample analyses struggle to find
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reliable evidence that taxes systematically affect value; see, e.g., Fama and French (1998).
5.4 The importance of historical and qualitative evidence
In “Economic Theory without History,” Gorton (2012, ch. 7) offers five caveats about research methods
in banking and macroeconomics that I believe fully apply to corporate finance: (1) “Economists tend to
dismiss the past as irrelevant. This is not based on serious testing or study, but on casual observation with
limited knowledge.” (2) “The relevant past is the history of market economies, not an arbitrary recent
period that is largely determined by data availability.” (3) “Without a historical perspective, economists
are myopic.” (4) (“Macro)economics is framed by what is measured even in the current period.” (5)
“Sophisticated empirical methods come at a large cost; the data requirements narrow our field of vision.”
Gorton’s (2010) research approach, of course, has greatly helped us understand the recent financial
crisis (and financial crises in general). It thus behooves us in corporate finance to consider carefully whether
our failure to solve the capital structure puzzle despite 60-plus years of intense research effort reflects our
unwillingness to adopt research approaches that take Gorton’s caveats seriously.
The implication is that we need to open up the lens and seek to understand the full historical evolution
of financial policies using approaches that exploit qualitative evidence when appropriate, and not restrict
attention to machine-readable recent data that seem attractive because they can serve as inputs to complex
large-sample econometric analyses.
This paper’s analysis of Ford and Sloan takes Gorton’s (2012) research perspective to heart and, in so
doing, it puts important new evidence on the table in a way that offers clear guidance for further (empirical
and theoretical) work. The remaining two sections of this paper are concerned with detailing that guidance.
6. Six “carry-away” implications of the data
This section discusses six general implications of the evidence from Ford and Sloan that are likely to
be useful in developing an empirically credible theory of corporate financial policy.
6.1 Reliable access to funding and indeterminacies in the components of financial policy
The most important “carry-away” of the paper is that the Ford-Sloan comparison points to a theory of
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corporate finance in which reliable access to funding is the central financial policy concern, with substantial
indeterminacies in the capital-structure, payout, and cash-balance components of financial policy.
When gauging the likely generality of this first “carry-away,” I would note that Ford and Sloan are
arguably the two most influential managers in corporate history. Their innovations on manufacturing,
marketing, and organizational design were adopted by many firms over the last 100 or so years. Sloan,
moreover, was closely allied with DuPont, a renowned pioneer in financial management practices, and he
was advised by John Jakob Raskob and Donaldson Brown, who are both historically prominent figures in
the development of such practices. It would therefore be surprising to find that the legions of managers
who followed Sloan and Ford largely ignored funding issues when choosing financial policies.
The next step, of course, is for studies to gauge directly the extent to which the findings for Ford and
Sloan apply to firms in other eras, lines of business, and stages of their corporate lifecycles. Perhaps most
importantly, Ford and Sloan were dealing with capital markets that were less developed than the markets
that modern-day firms can access. It is therefore possible that today’s managers of firms like FMC and GM
are less concerned with financial policies that emphasize funding access because they are more confident
that, if a funding need does arise, markets will find a way to meet that need. Whether or not that is true is
an empirical question, and one that deserves serious attention.
6.2 Interdependencies among components of financial policy
A second important “carry-away” is a need to move away from the silo structure of the empirical
corporate-finance literature. Tests for the determinants of leverage that do not give serious attention to both
the funding issue and to firm-specific interactions with equity-payout and cash-balance policies will likely
struggle – as the capital-structure literature has struggled for decades – to find economically meaningful
results linking leverage to underlying fundamentals.
For example, the data for Ford and Sloan indicate that both put primary (albeit very different) emphasis
on equity payouts, with consequent significant differences in their willingness to use debt as a transitory
funding vehicle. This distinction points to a need to move away from our presumption – generated largely
by the literature’s subordination of MM (1961) as fine-tuning MM (1958) – that payout policy is simply an
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input to the equity component of a firm’s debt-equity mix. The evidence instead points to payout policy
per se being of critical importance, with debt policy adapted to reflect that importance.
6.3 Focus on funding, not on the pecking order and not on optimizing the debt-equity mix
A third implication of the data is that it makes sense to move away from a focus on optimizing the debt-
equity mix. The emphasis should be squarely on funding, as in Myers and Majluf (1984), while modifying
their model to remove the conditions that lead to the empirically problematic pecking-order predictions
(Fama and French (2005, 2012), Frank, Goyal, and Shen (2020)).
A convincing and sensible way to do that is to expand the model from its original one-shot financing-
decision set-up to a dynamic set-up in which the option to borrow is valuable, so that a firm will issue equity
before exhausting its debt capacity. Debt will be used as a transitory funding vehicle and leverage will be
path-dependent: After borrowing, firms will use future earnings to deleverage proactively and restore the
option to borrow, just as people use credit cards to meet funding needs and then re-pay the debt (DeAngelo
and DeAngelo (2007), DeAngelo, DeAngelo, and Whited (2011), Denis and McKeon (2012), DeAngelo,
Gonçalves, and Stulz (2018)).
The evidence on Sloan and GM does point to approximate pecking-order behavior in terms of a general
tendency to prefer debt over equity issuance when raising outside capital. But it is a tendency, not a strict
preference, and Sloan treated dividend payments as an important use of funds, which deviates from how
they are treated in both the strict and modified pecking-order models. When one considers the empirical
shortcomings of those models, it becomes clear that it is the funding focus in Myers and Majluf (1984) that
deserves greater attention by theorists. The latter view draws additional support from the strong emphasis
that CFOs place on financial flexibility (Graham and Harvey (2001)).
6.4 Credit-rating targets, not leverage targets
A fourth implication of the data is that, although Ford and Sloan did not mention leverage targets, the
data nonetheless suggest a role for financial policy targeting. Specifically, a general managerial concern
about access to funding implies that issuer credit-rating targeting, as in Kisgen (2006, 2009) and
Hovakimian, Kayhan, and Titman (2009), is plausibly relevant, and almost surely more relevant than
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targeting of leverage (or any approach that puts the spotlight on optimizing the debt-equity mix). The
reason is that credit ratings gauge a firm’s overall financial strength, taking into account asset-side and
leverage considerations, both of which affect the capacity for meeting new funding needs.
The credit-rating point is about the importance of funding access, and is not a prediction that managers
will seek to keep a strictly stable credit rating for their firm. On the contrary, even when firms have a credit-
rating target, some degree of time-series instability in a firm’s actual credit rating is to be expected, with
endogenous actions by managers voluntarily contributing to that instability.
The underlying cause is the inherent tension between having reliable access to funding and using that
access. Access to funding is not valuable in its own right. It is valuable to have today because it gives you
the option to use it later when you need it. And when that access is used to a significant degree, credit
ratings will sometimes decline. Ideally, the decline will only be temporary. Even so, the expectation is
that it will take some time until the firm has deleveraged or rebuilt cash balances or taken other actions to
restore its former degree of overall financial strength, hence its former ability to obtain capital.
6.5 Managing with style
The evidence indicates that the values and judgments of top management were critical factors in why
GM and FMC had such different financial policies under Ford and Sloan. The implication is that managerial
uniqueness as in Bertrand and Schoar (2003) is a plausibly important determinant of financial policy.
6.6 Imperfect knowledge, Darwinian selection, and the culling of suboptimal financial policies
Sloan indicates that there is large scope for managerial judgment and substantial uncertainties about
how to conduct financial policy. This point suggests that Darwinian selection governs the evolution and
survival of corporate financial policies. The reason is that, if managers cannot detect material differences
in a set of possible choices for their firms, their choices will have a random component. Randomness should
result, through Darwinian selection, in the culling of truly bad decisions. For example, it is obvious that
managers have had enough experience to understand that it is, in almost all circumstances, a bad idea to
choose policies with a high risk of financial distress.
However, Darwinian selection would seem to take a very long time – if not effectively forever – before
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it would have any chance of culling all but the strictly best set of financing choices for a firm. Over horizons
of the length that managers deal with, it would be remarkable if selection eliminated the uncertainty about
the nature of optimal financial policies that Sloan highlighted.
To assess these evolutionary pressures empirically, a good place to begin would be with banking. One
reason is that there are many more years of experience with banks than with large publicly held firms, which
means more time for selection to cull bad financial policies. Another reason is that the business model of
banks inherently constrains the degree of indeterminacy in the components of their financial policies. An
important element of the bank business model is the production of liquid claims – e.g., deposit debt that is
redeemable on demand – for agents who value immediate access to funding and who willingly pay for it
through a lower yield on such claims (Diamond and Dybvig (1983), Diamond and Rajan (2001), Gorton
(2010), Gorton and Pennacchi (1990), Holmstrom and Tirole (1998)). A bank would lose an important
source of value creation (the loan-deposit return spread) if it did not have substantial debt in its capital
structure and if its asset structure were not tailored to support that debt (DeAngelo and Stulz (2015)).
The bank business model thus inherently limits the degree of indeterminacy in capital structure in a
way that the business model of a nonfinancial firm does not. A bank generates value through its capital
structure, e.g., from the loan-deposit spread, scaled up by the amount of deposit debt it has. In contrast, the
reasonable expectation is that value creation at a nonfinancial firm comes almost entirely from investment
(operating) policy, not from earning a premium on the amount of debt in its capital structure. With the
primacy of investment policy in mind, it makes sense that nonfinancial firms would care mainly about
reliable access to funding, and that there are nontrivial indeterminacies regarding the debt-equity mix or
other components of financial policy.
7. Concluding comments: The Holy Grail of understanding capital structure
Reliable access to funding is what really matters for corporate financial policy. The evidence provided
here in support of this inference is of a type that is unobtainable from the Compustat file, which is the
almost-universal source for the post-MM empirical literature on financial policy. Yes, the sample is small.
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But the evidence is the noise-free testimony of two of the most influential managers of all time who ran
two of the most important firms in the history of commerce.
This two-firm sample is thus arguably more informative about the financial policies of truly significant
firms than the many large-sample studies that draw inferences about the average firm in the Compustat file.
Compustat samples are dominated by small-to-medium-size firms on the economic fringe that typically
have less than 10 years of data in the file. The unequivocal evidence of the importance for Ford and Sloan
of access to funding at FMC and GM is arguably also more informative than Compustat-based analysis of
what matters for firms on the fringe. After all, it seems doubtful that GM under Sloan faced more difficult
access to funding than modern-day fringe firms.
Moreover, instead of knowing the principles that managers actually use to set financial policy, virtually
all large-sample studies try to tease out information on factors that influence managers’ decisions based on
(noise-filled) data that are restricted to quantifiable variables that Compustat happens to tabulate. See Frank
and Goyal (2009) for a long list of such variables that dominate the post-MM empirical literature, which
has yielded only a modest understanding of real-world capital structures.
I am not saying that Compustat-based studies are uninformative. I am challenging head-on the strongly
ingrained predisposition of modern-day researchers to dismiss automatically small-sample studies of the
type conducted here (of Ford and Sloan) as inherently less informative than large-sample studies.
Researchers’ bias against small-sample studies is faith-based: It reflects a belief that is not grounded in
evidence, namely that the law of large numbers will always reduce the noise from Compustat measures of
financial activity more effectively than judicious collection of smaller amounts of data that speak directly
and cleanly to the issue being researched. It seems clear that we would have a much better understanding
of capital structure today if, in the sixty-plus years since MM (1958), the literature had generated one small-
sample study per year that provided the clarity about other firms that the current study provides about the
financial policies of FMC and GM under Ford and Sloan.
The large differences in debt, payout, and cash-balance policies of Ford and Sloan should not be read
as establishing the existence of large degrees of freedom in the choice of these financial policy components
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for firms across the board, and especially not for economically marginal firms. FMC and GM were highly
successful firms under Ford and Sloan, and thus had more degrees of freedom in choosing the elements of
financial policy than weaker firms whose ability to generate value is more sensitive to finding specific
elements that reduce the true (but still not known with precision) costs of funding investment.
At the same time, however, we cannot dismiss the large differences in the debt, payout, and cash
policies of Ford and Sloan as minor anomalies if we are serious about having an empirically credible theory.
Any theory that cannot explain the differences and commonalities in the financial policies of FMC and GM
under Ford and Sloan leaves us far short of a credible solution to the capital structure puzzle.
The important implication: We need to move beyond models in which financial policies are uniquely
determined by a firm’s underlying economic fundamentals, including but not limited to the (static and
dynamic) tradeoff and pecking-order models that dominate the literature and textbooks.
The critical question, then, is: How should we approach the development of more refined theories that
can explain the differences in financial policies of the type documented here for FMC and GM?
To address this question, I would first note that I had planned to title this paper “Capital Structure: What
Really Matters?” but instead chose “Corporate Financial Policy: What Really Matters?” I will close the
paper by explaining my reasons for putting the spotlight on financial policy broadly instead of on capital
structure and, in so doing, outline my view of the best path forward for research on this set of issues.
Over the 60-plus years since MM (1958), the Holy Grail of corporate finance has been a theory that
explains capital structure. Although we have clearly made progress identifying factors that plausibly affect
the debt-equity mix, we still do not have a theory that does a decent job explaining even the broad-brush
features of observed capital structures. Why not? I see two key reasons.
One reason is that, as Yogi Berra would have said, we have been pursuing the “wrong” Holy Grail.
The “right” Holy Grail is understanding financial policy in a holistic sense, not capital structure per se.
Importantly, what really matters – reliable access to funding – is a property of a firm’s overall financial
policy, not of the capital structure component alone, because it depends on both sides of the balance sheet.
Consequently, it is simply not possible to understand capital structure fully without understanding financial
24

policy in a holistic sense.
The other reason is that I believe we need to recognize there are substantial indeterminacies in capital
structure. Why is that important? I believe that the capital-structure literature has been struggling to make
sense of a set of real-world (debt-equity) decisions that plausibly have material indeterminacies using
models in which those decisions are uniquely determined and thus ostensibly fine-tuned by managers.
I believe that the problem with this theoretical approach reflects Alfred P. Sloan, Jr.’s observation that
there is considerable uncertainty and room for judgment in selecting financial policies. The underlying
issue: Managers cannot tell with any real precision the features of a uniquely optimal capital structure (or
overall financial policy). If managers can’t detect material differences in a set of feasible choices, they will
treat those choices as if all are equally attractive, or essentially so.
Arguing in a similar vein, Myers (2020) cites Fama and French’s (1998) inability to detect tax effects
in real-world prices and then asks: “If PV(interest tax shields) are not observable, what hope is there for
theories based on other, more subtle complications?” Myers goes on to conclude: “financing theories that
depend on factors left out by MM work only if the factors have observable effects on market values. But
the value effects are obscured by noise and indeterminacy of fundamental value.”
I believe accordingly that we need to approach capital structure as one component of overall financial
policy, with two main principles in mind. First, emphasize reliable access to funding, while recognizing
there are substantial degrees of freedom in how such access is arranged, with nontrivial indeterminacies in
capital structure and other main components of financial policy.
Second, pay attention to Alfred P. Sloan, Jr. and take seriously the idea that managers cannot identify
optimal financial policies with reliable precision. Financial economists have spent 60-plus years trying to
understand capital structure with models in which managers have complete knowledge of how to choose
optimal policies in the face of myriad frictions, almost all of which have complex economic effects that
cannot be gauged precisely using even the most sophisticated empirical tools. The implication: We need a
theory in which managers face “unknown unknowns” and other forms of significant uncertainty that imply
they have seriously imperfect abilities to identify optimal financial policies.
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In broad-brush terms, here is what the data for Ford and Sloan suggest that such a theory would look
like. Managers inherently know that they need reliable access to funding because, without funding, they
cannot generate value from their business. No one is sure about the precisely best way to arrange such
funding, and so managers often perceive there are many combinations of debt, cash-balance, payout, and
equity-ownership decisions that are roughly equivalent in terms of providing reliable access to funding.
Consequently, there is no unique link (functional mapping) from the fundamentals of a firm’s business to
the chosen features of each of these constituent elements of overall financial policy. Choices still have to
be made, of course, and so the specific choices for a given firm turn on the judgment and objectives of
managers and influential shareholders, as in Bertrand and Schoar (2003) and clientele-based theories.
The main predicted commonality across firms is that, for each firm, the constituent elements of its
financial policy work together to provide an overall policy that provides reliable access to funding. In
comments on an earlier draft, Arthur Korteweg advanced a plausible corollary to this main prediction: The
idea that managers face large impediments to identifying the clearly best financial policies suggests that
seeking to avoid bad mistakes – e.g., avoiding substantial risks of financial distress that would seriously
impede funding access – may well be the most sensible decision rule for financial management.
With the focus of firms placed squarely on funding, this general mode of thinking about capital structure
– and more generally about financial policy – is rooted in the MM view that investment policy is the
dominant generator of value. It fits the data on Ford and Sloan and, indeed, comes from thinking about the
kind of theory that would make sense, given how Ford and Sloan described their financial policies.
It also resonates (with me) as far more useful than what textbooks emphasize. Is there any doubt that
a corporate focus on funding access is both more plausible descriptively and more helpful prescriptively
than telling students that debt ratios are (or should be) determined by balancing tax savings against distress
costs or that firms actually (or should) follow a pecking-order rule?
In any case, the message here is: The foundational problem of corporate finance is arranging reliable
access to funding, and understanding how firms address that issue is where our focus should be.
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Table 1
Henry Ford on Corporate Financial Policy
All entries in this table are quotes taken verbatim from Henry Ford’s memoir, “My Life and Work,” with
italics added for emphasis on points discussed in the body of the paper.
F1. “It has been our policy always to keep on hand a large amount of cash – the cash balance in recent
years has usually been in excess of fifty million dollars. This is deposited in banks all over the country,
we do not borrow but we have established lines of credit, so that if we so cared we might raise a very
large amount of money by bank borrowing. But keeping the cash reserve makes borrowing unnecessary
– our provision is only to be prepared to meet an emergency.”
F2. “The thing is to keep money and borrowing and finance generally in their proper place, and in order
to do that one has to consider exactly for what the money is needed and how it is going to be paid off.”
F3. “Borrowing for expansion is one thing; borrowing to make up for mismanagement and waste is quite
another. You do not want money for the latter.”
F4. “If a man’s business is in excellent condition and in need of expansion, it is comparatively safe to
borrow. But if a business is in need of money through mismanagement, then the thing to do is to get into
the business and correct the trouble from the inside – not poultice it with loans from the outside.”
F5. “I have no prejudice against proper borrowing. It is merely that I do not want to run the danger of
having control of the business and hence the particular idea of service to which I am devoted taken into
other hands.”
F6. “The average successful banker is by no means so intelligent and resourceful a man as is the average
successful business man. Yet the banker through his control of credit practically controls the business
man.”
F7. “I have always insisted on the payment of small dividends and the company has to-day no
stockholders who wanted a different policy. I regard business profits above a small percentage as
belonging more to the business than to the stockholders….If it at any time became a question of lowering
wages or abolishing dividends, I would abolish dividends.”
F8. My ambition is to employ more and more men and to spread, in so far as I am able, the benefits of
the industrial system that we are working to found; we want to help build lives and homes. This requires
that the largest share of the profits be put back into productive enterprise.”
F9. “The stockholders, to my way of thinking, ought to be only those who are active in the business and
who will regard the company as an instrument of service rather than as a machine for making money….
F10. “This policy does not agree with the general opinion that a business is to be managed to the end
that the stockholders can take out the largest possible amount of cash.”

Table 2
Alfred P. Sloan, Jr. on Corporate Financial Policy
All entries in this table are quotes taken verbatim from Alfred P. Sloan’s memoir, “My Years With General
Motors,” or from interviews of Sloan published in the New York Times on June 13, 1927 and September
12, 1935. Italics have been added for emphasis on points discussed in the body of the paper.
S1. “The strategic question in industrial finance, assuming you have something to work with in the way
of a going business, is how to optimize its elements. The latitude for opinion, or subjective judgment
here, is wide.”
S2. “…from 1921 to 1946 the corporation avoided long-term debt. I myself had feelings against debt,
perhaps because of what I had seen of it in my experience. And yet I cannot say that we had an antidebt
policy in that period. The facts show that we were generally able to do without it…..In other words, we
paid off and grew, without debt, except for bank loans, during short periods in the 1930s. The 1930s
being a time of consolidation, the question of debt did not arise. During the war years, we arranged for
a bank credit of $1 billion, through the government, to finance receivables and inventories, but
borrowings under those arrangements were limited.”
S3. “The additional capital essential to the financing of this development” (i.e., growth of the business)
“may be obtained in various ways. If the development is not too rapid it is possible that all of the
additional funds needed may be obtained through a reasonable retention of earnings.”
S4. “On the other hand, the growth may be so rapid that a reasonable retention of earnings reinvested
in the business would not be sufficient to properly finance the development and maintain a solid financial
foundation. In such cases, the new capital must be obtained from the outside.”
S5. “From the standpoint of the common stockholder, the preferable way is through the sale of senior
securities, so long as such securities are amply protected by common stock equity and maintain a
satisfactory position in the market. Note issues, with definite time to run, can frequently be sold under
favorable conditions at attractive prices, but in such cases there must be the assurance of being able to
take care of the maturity at the pre-established time without undue sacrifice. The sale of common stock
is an avenue that is usually open and should be resorted to where the additional issue of senior securities
would prejudice them from an investment standpoint.”
S6. “…to continue the sale of senior securities to meet the entire capital requirements would result in the
course of time in a disproportionate amount of senior securities in relation to the common stock equity.”
S7. “The question therefore resolves itself into the determination of a fair and equitable division of the
earnings into parts, not necessarily equal parts. I mean by this that the stockholders should receive an
equitable share of the earnings representing a return on their partnership interest in the enterprise. It
is equally important, and to their interest, to protect the future of the corporation by reinvesting a part
of the earnings to provide for future development, as well as to afford the necessary protection of its
financial structure.”
S8. “The directors of General Motors have consistently taken the position that there should be only two
considerations in determining dividend action -- first, earnings, which alone make dividends possible,
present as well as future; second, the future (capital) needs of the business...”
(table continued)

Table 2 continued
S9. “The most important point I want to make is that General Motors stockholders can rely upon the
directors to pass on the largest possible share of the earnings consistent with the needs of the business.”
S10. “…the problem of dividend policy is not always a simple one. A rate of dividend when once
declared carries with it the desirability of continuity. The declaration must reflect not only the current
condition of the business but there must be considered the future trend, especially with respect to
prospective earnings and possible capital needs. Under conditions existing today, such an appraisal is
difficult.”

Table 3
Debt, Dividends, and the Funding of the Post-World War II Expansion at General Motors Corporation: 1945 to 1956
The data are from company annual reports and Compustat. Except for ratios, all data are in millions of dollars. The cumulative excess dividends amount in a given
year, T, equals the larger of zero and the difference between actual dividends in year T and $132 million (dividends in the baseline year 1945). For example, in
1948, the excess dividend is 198 – 132 = 66 while, in 1949, the excess dividends amount is 351 – 132 = 219. Cumulative excess dividends as of 1949 are 66 + 219
= 285. The debt and assets figures in rows 1, 8, and 9 include consolidated balance sheet values for General Motors Acceptance Corporation (GMAC).
$ millions (except ratios) 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956
1. Debt/total assets 0.001 0.094 0.119 0.160 0.197 0.203 0.200 0.220 0.274 0.297 0.321 0.364
2. Dividends/net income 0.701 1.133 0.459 0.449 0.535 0.631 0.692 0.625 0.583 0.542 0.498 0.652
3. Cumulative capex 114 402 589 732 862 1,038 1,298 1,641 2,142 2,897 3,505 4,396
4. Cumulative net income 188 276 564 1,004 1,660 2,494 3,001 3,559 4,157 4,963 6,153 7,000
5. Dividends 132 99 132 198 351 526 350 349 349 437 592 553
6. Cumulative dividends 132 231 363 561 913 1,439 1,789 2,138 2,487 2,923 3,516 4,068
7. Cumulative excess dividends --- 0 0 66 285 679 898 1,115 1,332 1,636 2,096 2,517
8. Change in debt -5 192 124 228 274 319 23 233 697 369 1,068 183
9. Debt 1 193 317 545 819 1,139 1,161 1,395 2,092 2,461 3,529 3,712
10. Stock sales to public 0 0 0 0 0 0 0 0 0 0 325 0

11. Stock sales to employees 0 5 0 6 8 10 14 19 25 31 34 42
12. Stock repurchases 0 0 6 7 11 29 24 32 33 40 49 47
13. Net stock sales 0 5 -6 -1 -3 -19 -10 -13 -8 -9 310 -5

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Corporate Financial Policy: What Really Matters?

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Corporate Financial Policy:

What Really Matters?

JEL classification: G32, G35

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What Really Matters?

dominate the empirical literature and textbooks.

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you want to read only one book about business.”

FMC and GM conform to the principles articulated by Ford and Sloan.

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credit lines that provided the option to borrow in a funding emergency.

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to sell FMC shares and diversify its portfolio.

large number of public shareholders.

banking services to customers to foster purchases of consumer durables.

3. Henry Ford on corporate financial policy

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reader to examine them directly in Table 1.

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is what really matters when managers select financial policies.

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amounts of debt outstanding at FMC and very large cash balances.

dividend-avoidance policies that Ford described in his memoirs.

4. Alfred P. Sloan, Jr. on corporate financial policy

policies that seem reasonable to the decision maker.

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equivalent in their eyes.

4.1 Debt and funding

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has enough cash to cover the investment outlay.

4.2 A strong commitment to pay dividends

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4.3 GM’s post-WWII expansion: Funding, debt, and dividends

about the coming boom in demand.

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substantially increased payouts to its shareholders.

needs defined to include both investment outlays and equity payouts.

4.4 Operating flexibility: Large-scale worker layoffs

production pressures in boom times.

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outlays over the same period.

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continued) commitment to large equity payouts to thank for that.

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5.1 What the data show: Key findings

borrowing, but Sloan was clearly more tolerant of debt.

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avoid borrowing except in emergencies.

fashion under both Ford and Sloan.

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ownership and debt, cash, and equity payouts.

5.3 What about economic rents, agency costs, and taxes?

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5.4 The importance of historical and qualitative evidence

unwillingness to adopt research approaches that take Gorton’s caveats seriously.

large-sample econometric analyses.

6. Six “carry-away” implications of the data

be useful in developing an empirically credible theory of corporate financial policy.

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indeterminacies in the capital-structure, payout, and cash-balance components of financial policy.

an empirical question, and one that deserves serious attention.