Corporate Finance Over the Past 25 Years

Brennan, Michael J., 1995, “Corporate Finance Over the Past 25 Years,” Financial Management, Vol. 24, No. 2, Summer 1995, 9-22.

Purpose:  To review the development of corporate finance research over the period 1970-1995.

Four Chief Developments:

  • One development has relaxed the constraints of the classical MM (Modigliani-Miller) paradigm.
    • The MM theories about dividends and capital structure take firm cash flows as given, and study how the distribution of that income affects its total value.
    • Analysis later shifted to asking how the structure of claims against the cash flow affects the flow itself, which led to studies of the several types of securities issue.
    • Research in 1970 examined the overall corporation; in 1995, it looks more at specific events or transaction types, such as IPOs, takeovers, repurchases of equity, etc.
  • Another development recognizes that managers are not perfect agents (the agency problem).
    • Newly recognized facets of agents’ opportunities and preferences include their information endowments, their discretionary powers, the nature of the incentives embodied in their contracts, their non-financial compensation (perquisites, reputation, power, etc.), and aversion to effort.
  • A third development has replaced the traditional assumption of actors as price-takers with analyses of games under incomplete information. Analysis has begun to move away from discounted cash-flow modeling, and toward techniques similar to those used in pricing options.
  • A fourth development has realigned the aims of argument:
    • Scholars in 1970 were concerned with the implications of the structure of institutions. Their counterparts in 1995 are more interested in institutional structures as responses to specific problems, and in either defending the structures or proposing new ones.

 

Other Trends:

  • In 1970, bankruptcy was largely ignored, held as synonymous with liquidation, or treated as a cost to offset the tax savings of debt in determining optimal capital structure. Research in 1995 separates direct from indirect bankruptcy costs (and recognizes the latter as substantial); distinguishes between reorganization, bankruptcy, and liquidation; and examines the connection between bankruptcy laws and efficient liquidation.
  • A general trend in corporate finance has been a move away from efforts to prescribe how financial decisions ought to be made, and toward descriptions or explanations of how and why actual decisions are made.

 Unexplored Territory:

As of 1995, little attention had been given to the analysis of knowledge-based firms whose most important capital is autonomous employees (corporate finance research of the past generally assumed that firms relied on physical capital), or to the implications of increased globalization on corporate financial decisions and structures.