The theory of corporate finance: A historical overview

Question 1

What characterizes corporate finance research before the 1950s?

Answer 1

It was ad hoc and institutional, with descriptive studies focused on firm behavior over the life cycle.

Question 2

Who was a key figure in early corporate finance research, and what was his focus?

Answer 2

William Dewing, who studied firms’ financial decisions throughout their life span

Question 3

What changed in corporate finance after the 1950s?

Answer 3

It adopted positive theories that analyzed financial decisions using economic models and analytical tools.

Question 4

What is meant by “positive theory” in corporate finance?

Answer 4

A framework that focuses on explaining and predicting financial behavior and its consequences, rather than prescribing it.

Question 5

What were the traditional three main concerns of early corporate finance?

Answer 5

Optimal investment, financing, and dividend policies.

Question 6

What key limitation existed in early corporate finance regarding decision-making?

Answer 6

It overlooked how individual incentives (like managers’ self-interest) could affect corporate decisions.

Question 7

Why is the concept of “equilibrium in financial markets” important in modern finance?

Answer 7

It explains how prices, risk, and information interact to determine financial outcomes, which early finance ignored.

Question 8

How does modern finance address the limitations of early theories?

Answer 8

By incorporating incentive structures, agency problems, and market equilibrium models to explain real-world behavior.

Question 9

What’s the focus of modern finance?

Answer 9

“What are the effects of alternative investment, financing, or
dividend policies on the value of the firm?”