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«Volume Title: Conference on Research in Business Finance Volume Author/Editor: Universities-National Bureau Volume Publisher: NBER Volume ISBN: ...»

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Close observation of the nature and use of financing forms by businesses, and their changes through time, provides useful data for a theory of managerial decision-making, because they reflect the adaptations made by suppliers of funds to meet the scale of preferences in. forms of financing demanded by businesses. Such studies cannot per se provide the basis for a theory, because they cannot reveal the nature of the financing management would undertake if its choices were unrestricted. Up to the present time, these studies of types of financial contracts and their uses have increased the number of determinative factors of which students have become aware. They have shown clearly that simple comparisons of the cost of funds under different forms of contracts are not the sole, or even the most influential, determinant at work.

Historical Studies of Firms and Industries A body of literature that throws further light on influences governing managerial preferences in selecting forms of financing is that of business history. This is defined to include objective, systematic studies of the history of individual entrepreneurs, managers, enterprises, or industries, focussed upon the evolution of business concerns. Although the mass of American historical literature is immense, business history as a field of scholarship is relatively new. Viewed against the enormous potentialities of the field, it is apparent that only a beginning has been made. The pioneering accomFACTORS INFLUENCING MANAGEMENTS plishments of N. S. B. Gras and his associates in the area must here be noted. 28 Many general business histories include sections or chapters on financial policy and administration, and these are worthy of examination for the information they yield about choices of forms of financing and motivating considerations.2° Unfortunately, much of this literature has been eulogistic and uncritical, or, at best, unanalytical: The writers have not been conscious of alternative policies open to the firms they were considering, and in consequence they have failed to treat financial policy with fullness and discrimination.

While financial histories of American enterprises are rare,3° historical studies of financial administration — including policy formation, control, and management — appear to be nonexistent.3' Systematic histories in this field might be expected to convey, more directly and intimately than is possible by any other technique, knowledge of the forces bearing upon financial decisions. Histories of the administration of an enterprise would represent case studies, but with more penetration and elongated time dimension. They can provide the full setting of social, economic and political forces within which the firm's administration occurred. Whereas the case study usually centers attention upon a particular problem, introducing historical material as a background for understanding the current issue, a history of administration would necessarily include the formulation and execution of policies to deal with a succession of financial episodes in the See especially: N. S. Gras, Business and Capitalism (New York: Crafts, 1939);

N. S. B. Gras and H. M. Larson, Casebook in American Business History (New Crofts, 1939); and the numerous citations to Professor Gras, his associates and students in H. M. Larson, Guide to Business History (Cambridge: Harvard University Press, 1948). Studies of entrepreneurship are being conducted under A. H. Cole at Harvard.

See, for example: H. Allen, The House of Goodyear (Akron: W. S. Dutton, 1936);

H. K. White, History of the Union Pacific Railway (Chicago: University of Chicago

One Hundred and Forty Years (New York:

•Press, 1895); W. S. Dutton,

Scribners, 1942); B. Emmet and J. E. Jeuck, Catalogues and Counters (Chicago:

University of Chicago Press, 1950). Studies of industries and firms, oriented to analysis of price policies, sometimes contain useful evidence on financial policy formation.

3° Among the more substantial financial histories may be mentioned: E. S. Meade, Trust Finance (New York: D. Appleton, 1903); L. H. Seltzer, Financial History of the American Automobile Industry (New York: Houghton-Mifflin, 1928); J. W.

Stehman, The Financial History of the American Telephone and Telegraph Company (New York: Houghton-Mifflin, 1925); C. R. Flint, Memories of an Active Life (New York: Putnam's, 1923).

Cf. H. M. Larson, op. cit., p. 765.


survival, growth, or decline of the firm. They would encompass the dynamics of management, and would be productive of new insights into the nature and process of decision-making.

Because financial decision-making is inseparably bound up with business policy in general, what is needed is not more financial histories per Se, but more general business histories sufficiently detailed, intensive and discerning in their conception to reveal clearly the interrelationships between decisions among forms of financing and other business decisions.

To possess maximal value, such studies would need to be the joint product of a cooperating group of historians, economists, and specialists in business policy, or of individuals possessing a combination of these talents.

Recapitulation Current knowledge about factors influencing decisiOns on forms of business financing is fragmentary and incomplete. Much has been learned on an aggregative basis about the relative quantities of funds in use by businesses that have been obtained in different forms. Helpful information has been assembled about the nature of the various contracts utilized in business financing, and the frequency of their use. Suggestive hypotheses have been advanced regarding appropriate financial policies (i.e., sets of financial decisions) by businesses operating under different sets of circumstances. For the most part, these hypotheses are untested by application to adequate samples of enterprises, and in some instances they are internally inconsistent. There are few tested and confirmed theories about the variables that are combined in determining the financial plan of a particular concern.

Present formulations of factors influencing managerial choices of financingare deficient in two principal respects. First, they embrace relatively a much smaller number of variables than appears to be operative.

Secondly, they provide little empirical evidence that the variables they do include are the most important. This suggests the need for a more comprehensive frame of reference, including all of the influential factors, and the necessity of placing them in a significant relationship to each other.


Casual observation reveals a disconcerting diversity among firms with respect to the structure of their liabilities and their financing patterns. This alone should suggest to an observer that the choices made by business managements with respect to the forms in which they obtain funds are based upon consideration of a large number of factors. It suggests diversity in the


weighting of these factors by different managements at the same time, and diversity in their weightings by the same management at different times. It is a plausible inference that no simple explanation of the financial rationale of American business management is valid.

Direct Influences on Managerial Decisions

In constructing a comprehensive frame of reference for the analysis of choices of forms of financing, a valuable point of departure is the decisionmaking process in the enterprise. It is desirable to inquire, initially, into such questions as these: Who are the financial decision-makers, and what is their relationship to the owners and directors of the firm? What are the attitudes and motivations of financial decision-makers, and by what factors are they determined? What issues give rise to financial decisions? What are the relationships between financial decisions and production, marketing, personnel, product-line, pricing, equipment, inventory and other types of decisions made by business managements?

Without attempting to develop a complete theory of business management, one may recall certain generally known features of American corporate organization and management. According to statute, the business corporation is operated by a board of directors elected by the stockholders.

Typically, the board of directors delegates to a president broad authority to operate the enterprise in accordance with the policies it approves. The president, in turn, redelegates important segments of his authority to major functional or divisional executives. The president and his lieutenants ordinarily initiate proposals for new policies or changes in existing policies, and submit them to the board for consideration and approval. If a majority of members of the board consists of active "outside" (i.e., nonmanagement) directors, the board may exert a strong independent influence upon the firm's policy, including choices of forms of financing. If, on the other hand, the majority of the directors are either operating executives of the enterprise or more or less passive "outside" members, the proposals of management will be more or less automatically adopted. This is especially likely to be true if the operating executives are themselves substanL tial stockholders in the enterprise.

In almost all instances the active initiation of financial policies, if not the formal act of decision, is undertaken by management, even though some decisions require the approval of the board of directors, and certain major issues — such as recapitalization, merger, or sale of essential assets — must be ratified by the stockholders. It follows that the attitudes of management toward risk assumption, toward its own security of position, and toward the maintenance of its freedom to exercise wide discretion


in operating the business, are highly important determinants of forms of financing. On the assumption that the cost of funds under various types of contracts is similar, management will choose that type of financing contract which minimizes the exposure of the enterprise to risk of insolvency, which least threatens its continued control of policy, and which maximizes its ability to act flexibly in meeting future contingencies.

Observation suggests that managements differ considerably in their evaluation of risks, and that these differences are also highly important in the choice of financing forms. Some management groups, because of age, business experience, relative security of tenure or other factors, are optimistic, aggressive and inclined to accept risk. Other management groups display the opposite characteristics.

We may conceive of two enterprises that are identical in every characteristic, excepting in the propensities of their managements to assume risks.

One management, optimistic and'daring, will choose a form of financing its requirements that exposes the firm to a material risk of insolvency, should events turn out unfavorably, because it evaluates these risks as of small magnitude. The management of the other firm, cautious in its attitude, will choose a financial contract carrying less risk, because it evaluates the risks carried by the first firm's contract in relatively large terms.

Yet the risk inherent in the situation confronting the two enterprises may be indistinguishable to a competent and impartial observer.

The theorist may argue that such a difference in managerial behavior is "irrational." Illogical reasoning may, of course, provide part of the explanation. In all probability, however, the contrast in financing policy of the two firms is due to incompleteness of the information required fOr a "rational" decision, to differences in the bodies of data actually taken into account, and to divergence in the psychological approaches of the two management groups to the interpretation of such knowledge as is available.

In a dynamic economy, managerial decisions are inevitably made in the face of uncertainty and upon the basis of incomplete infonnation. The decision-making process is a connected and continuous chain, in which the necessity for financial decisions arises out of decisions to add new products to the firm's line, to explore new markets, to augment production rates, to mechanize operations, or to accumulate inventory against an At the time any one decision is made, it is rarely anticipated rise in possible to anticipate all of the other issues of policy that will follow in its wake. Scientific study of management problems and forehanded planning can improve the quality of decisions, but they can scarcely be expected to eliminate the need for "judgment" by decision-makers. So long as this is


true, the psychological attitude of managers toward risk will continue to be an independent variable in the choice of financing forms.

The preceding discussion assigns to management the active and initiating role in financial decisions. This should not be taken to mean that the owners of the enterprise or the board of directors lack influence, that the interests of managers and of stockholders are typically divergent, or that the special interests of executives take precedence. Nor does it imply that maximization of the present value of the firm is not the guiding economic principle of managerial behavior. Even where the ownership and management groups in a business enterprise are separate, and stockholders are numerous and dispersed, stockholders and the board of directors always retain a powerful potential influence upon management and its decisions.

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