[PEN-L:11361] REVIEW: History of Corporate Finance (fwd)

[Michael Hoover <hoov@xxxxxxxxxxxxxxxxx>]

Forwarded message:
> Date:         Sun, 20 Jul 1997 12:50:51 -0500
> From: Michael Rempel <stdmire@xxxxxxxxxxxxxxxxxxxxxxx>
> Subject:      REVIEW: History of Corporate Finance
> To: SOCIAL-CLASS@xxxxxxxxxxxxxxxx
>
> Date: Sun, 20 Jul 1997 10:21:33 -0400
> From: "K. Austin Kerr" <akerr@xxxxxxxxxxxxxxxxxxxxxxxxxx>
> ================= H-BUSINESS POSTING =================
> H-NET BOOK REVIEW
>
> Published by H-Business@xxxxxx (July, 1997)
>
> Jonathan B. Baskin and Paul J. Miranti, Jr. _A History of
> Corporate Finance_. New York: Cambridge University Press, 1997. x
> + 350 pp. Tables, epilogue, appendices, notes, and index. $29.95
> (cloth), ISBN 0-521-55514-0.
>
> Reviewed for H-Business by Robert E. Wright, Temple University
> <alexande@xxxxxxxxxxxxx>
>
>    The Alleged Poverty of Positivism and the Modern Theory of
> Finance
>
> _A History of Corporate Finance_ is a solid contribution to
> scholarship that should gain the interest of historians, lawyers,
> economists, and business persons. Its unusual combination of
> scope, clarity, and brevity, combined with its reasonable price,
> may induce professors to make it required reading for advanced
> undergraduate and graduate courses in economic or business
> history, or in management education courses. Highly interpretive,
> the book is more a work of synthesis than of original research in
> primary sources. At 350 pages, the book is hardly comprehensive,
> but it nevertheless manages to tie much temporally disparate
> material into its thesis.
>
> That thesis the authors lay out carefully in the introduction,
> "History and the Modern Theory of Finance." Citing Keynes and
> Schumpeter, Jonathan Baskin and Paul Miranti remind readers of
> the "complementary" nature of history and finance and announce
> their intention to employ "historical methods to amplify an
> important contemporary paradigm" (pp. 1-2). That paradigm, the
> "modern theory of finance," seeks to evaluate the "financing
> question" (optimal capital structure decisions), and the
> "dividend question" (distribution of income to shareholders). The
> early leaders of modern finance theory were Franco Modigliani and
> Merton H. Miller. Based on an abstract model, they argued that
> "firms cannot increase value by issuing either debt or equity"
> and that "managerial decisions are irrelevant" (p. 16).
> Questioning conclusions based on what they consider to be
> ungrounded, formalized models, Baskin and Miranti argue that the
> modern theory of finance needs to take greater recognition of
> "path dependence and historical evolution" (p. 3). To
> substantiate their view, they describe the intellectual history
> of economics (economiography?) since the diffusion of Karl
> Popper's "falsifiability" philosophy of science, and, at the end
> of each chapter, they test the assumptions and real-world
> applicability of theoretical models. Generally, they find the
> abstractions empirically deficient, and thus call into question
> "the profession's current infatuation with models that lend
> themselves to formal mathematical explication" (p. 23).
>
> Divided into three parts, "The Preindustrial World," "The Rise of
> Modern Industry," and "The Transition to the Contemporary Era,"
> the main body of the work opens with a discussion of medieval and
> renaissance finance. After a brief description of the medieval
> commercial revival, Florentine and Venetian finance is treated at
> some length with emphasis on enterprise organization. The authors
> conclude, not surprisingly, that "other factors than those
> considered in the modern theory as laid down by Modigliani,
> Miller and others had been foremost in defining early financial
> institutions" (p. 51).
>
> Corporate finance in the age of global exploration, especially
> the rise of joint-stock trading companies like the East India
> Company, forms the basis of chapter 2. Baskin and Miranti
> conclude that the "pecking order" hypothesis of Gordon Donaldson,
> "the traditional explanation of funding decisions prior to Miller
> and Modigliani," best explains the East India Company's financial
> decisions (pp. 22, 84). Donaldson's hypothesis predicts
> organizations will finance operations first from retained
> earnings, then from debt, and lastly from the sale of additional
> equity.  With debt interest rates lower than equity returns,
> business cycles violent, and the probability of losing control of
> the company in an equity expansion high, East India Company
> managers borrowed capital with short-term debentures.
>
> Chapter 3 takes up the emergence of public markets for investment
> securities from the Glorious Revolution to the final defeat of
> Napoleon. Predictably, the Bank of England, John Law, and the South Sea
> Bubble are the major subjects covered, but an interesting twist,
> the notion that the "watershed of 1720" caused British and French
> financial development to diverge markedly, enlivens the
> discussion. If true that France turned "antitrade and antimarket"
> after the "Law fiasco," the authors have hit upon a major
> explanation for the Anglo-American victory in the struggle to
> control North America (French and Indian War [1755-1764] or Seven
> Years' War [1756-1763]) and an important cause of the French
> Revolution (p. 114). In any event, Baskin and Miranti's main goal
> in the chapter is again to attack the modern theory of finance by
> pointing to the "high risk in economic affairs and poor
> information" facing eighteenth-century investors. In that
> environment, low-risk government debt was a more attractive
> investment option than equities (p. 122).
>
> The problems involved in accurately valuing equities persisted
> into the nineteenth century, the age of massive infrastructure
> improvements. With particular emphasis on canal and railroad
> corporations, the authors describe the evolution of preferred
> stock, a hybrid between debt and equity financing. Preferred
> stock paid a guaranteed dividend, but conferred no voting
> privileges, thereby allowing managers to maintain control over
> the corporation. Also, unlike bond payments, dividend payments
> could be suspended without forcing the corporation into
> receivership. The creation of preferred stock, the authors
> believe, supports the "pecking order hypothesis" more than the
> modern finance theory. By incorporating the fixed-income and
> non-voting characteristics of debt instruments into a hybrid
> equity form, managers transcended some of the limitations of the
> pure debt market and staved off the flotation of true equities.
>
> After 1900, the authors admit in the next chapter, a broad,
> impersonal market in common stock arose in both Britain and the
> United States. Managers, however, continued to prefer retained
> earnings, fixed debt, and preferred stock over the flotation of
> common stocks. The main body of the book concludes with two long
> chapters of in-depth analysis of the financing of center firms,
> conglomerates, and leveraged-buyout partnerships. Not
> surprisingly, the pecking order hypothesis again emerges as the
> key means of understanding successful corporate financing
> strategies. By downplaying the successful initial phase of the
> post-1960s merger movements, the authors portray conglomerates
> and LBOs as failures inspired by the over-simplistic models of
> academics. For instance, they label Henry G. Manne's contract
> theory "underspecified" because it fails to account for the
> effects of government regulation and the importance of manager
> tenure (p. 287).  However, Baskin and Miranti admit that although
> the pecking order hypothesis generally "predicts the progression of
> corporate financial preferences, it does not provide guidance
> with respect to either the relative weight placed on these
> alternative sources or the rates at which this process
> progressed" (p. 297).
>
> The basis of _A History of Corporate Finance_ is Baskin's
> dissertation and 1988 _Business History Review_ article, "The
> Development of Corporate Financial Markets in Britain and the
> United States, 1600-1914: Overcoming Asymmetric Information."
> Baskin died before completing revisions, but Paul Fink, Baskin's
> father, arranged for Miranti to bring his son's contribution "to
> fruition" (p. ix). Probably because of the difficulties of
> editing a half-posthumous piece, the book suffers, in places,
> from an over-rigid style, poor balance, and uneven organization.
> Over one-half of the book, for instance, covers the twentieth
> century.
>
> Also, the epilogue and two appendices seem out of place. The
> former reads like a conclusion except for the formulation of an
> original algorithm that purports to explain the relationship
> between short-term, firm-specific factors and long-term
> environmental elements in financial development. If truly
> significant, the algorithm should be explained in the
> introduction and applied throughout the narrative. Appendix A, a
> short description of finance and informational asymmetries in the
> ancient world, rightfully belongs in chapter 1. Appendix B,
> "International Patterns of Corporate Governance," contrasts
> Anglo-American financial markets with their equivalents in Japan
> and Germany. The main contention is that, because of its
> transmission of "reliable information" to investors, the
> Anglo-American financial system is more efficient and conducive
> of economic growth than the "opaque regimes of Japan and Germany"
> (p. 322).
>
> Although probably correct and extremely interesting, the
> presentation is _ad hoc_ and, at 8 pages, too truncated to be
> entirely convincing. I hope that Miranti will take up a broad,
> comparative study of financial institutions since the late
> nineteenth century as his next major project.
>
> Although an outstanding study that will deservedly gain a wide
> audience, the book ultimately fails to reconcile the methods and
> outlook of history with those of economics. The belated algorithm
> is a step in the right direction, but still short of creating
> realistic (adequately specified) models that can be
> quantitatively tested. Though it is true that some past models
> have been unrealistic in some regards, nothing in this book will
> convince economists to abandon formal, mathematical theorizing.
> Baskin and Miranti, in other words, have rightly called the
> modern theory of finance into question, but have not set forth a
> completely viable alternative.
>
> Copyright (c) 1997 by EH.Net and H-Net, all rights reserved.  This work
> may be copied for non-profit educational use if proper credit is given to
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