Financial economics is management thought: a narrative history of corporate finance theories advocating shareholder value constructions

Abstract

Purpose The purpose of this study is to demonstrate that financial economics must be understood as management thought. Key financial economic theories advocate a specific view of management and organizations, namely, the maximization of shareholder value (wealth). Design/methodology/approach This study’s methodology is a narrative history of three financial economic theories and their connection to the organizational purpose of maximizing shareholder value. The three theories are Fisher’s capital-income theory, Ronald Coase’s view of firms underlying transaction cost economics and agency theory. Findings These three financial theories build the same theory, namely, Fisher’s capital-income theory. This theory claims that future monetary flows (wealth) paid to shareholders discounted by a compound rate can explain markets, firms’ prices and even capitalism. Franco Modigliani and Merton Miller relaunched this theory. Coase’s view of firms addresses a difficulty in capital-income theory: if markets are perfect, why is there a need for firms to partially organize production outside the market system? Coase’s answer is because of the costs of using the market price mechanism in the allocation of resources, which reduce the forecasts of future economic benefits. Otherwise, the market would be applied to allocate resources. This view was later developed into transaction cost economics by Oliver Williamson and other scholars. The agency theory from Michael Jensen and William Meckling is just an application of capital-income theory, where firms exist to increase shareholders’ wealth, and managers should receive large salaries and bonuses to ensure this. Agency costs are a type of transaction cost economics that explains the existence of firms. Research limitations/implications Future research can explore the relevance of financial economic theories for management thought and practice. This study was developed exclusively from document (archival) evidence. Practical implications A better understanding of this source of management thought may be helpful for developing new management theories. Originality/value This study demonstrates that financial economic theories contain important elements of management thought, although they are often classified as unrelated to management theory. It provides a narrative history of financial economic theories related to shareholder value constructs.