CORPORATE FINANCE

Session 09

Conclusion

Finance is not a hard science. A hard science is a science with a powerful predictive capability.

Soft sciences begin with a descriptive stage, and then go on to being a toolbox of rules and applied principles. That's where Finance is.

Physics became a hard science with Descartes, Galilée and Newton, in the XVIIth century.

Medicine became a hard science with Pasteur in second half of the XIXth century.

Finance as well as Economics are still at the stage of being toolboxes. One of the problem is that they depend very much upon human psychology and in particular upon attitudes toward expectations (a phenomenon very difficult to formalize and make into a predictive theory).

What we do know : the seven most important ideas in Finance (from Brealey and Myers)

• Net present value and DCF

• The Capital Asset Pricing Model

• Efficient capital markets (the three hypotheses from weak to strong)

• Value additivity of PV's

• Capital structure theory (Miller Modigliani) : modifying the capital structure (liability structure) of a firm, for instance some shareholders replaced by bondholders, does not change the value of the remaining shares. The yield change, though, but the risk too.

• Option theory (Black & Scholes)

• Agency theory

What we do not know : ten unsolved problems in Finance

• How are major financial decision made ?

• What determines project risk and present value ?

• Risk and return - what have we missed ?

• How important are the exceptions to the efficient market theory ?

• Is management an off balance sheet liability ?

• How can we explain the success of new securities and new markets ?

• How can we resolve the dividend controversy ?

• What risks should a firm take ?

• What is the value of liquidity ?

• How can we explain merger waves ?

For a good general presentation of the evolution of ideas in Financial theory : http://cepa.newschool.edu/het/schools/finance.htm