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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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Some of the internal factors affecting management decisions on forms of financing are (and I do not necessarily put these in order of importance): age of management (young management may be inclined to take more risks than old management, and this is irrespective of the experience of that management); the degree of the entrepreneurial or ownership forces represented on management (if management has a relatively small ownership interest in the company, the degree of risk which it is willing to take may be greater or less than if it represents substantial ownership in the company); duration of management (how long it has been in office or how long it anticipates remaining in office — in other words, can its plans be on a long-range basis or must it obtain maximum benefits at the earliest possible moment?). The authors of the paper suggest case studies from the financial history of corporations. This would be intensely interesting, but please remember when these studies are made that in many cases the

• patterns shown will have developed under the influence of various managements, not under any continuity of management.

A factor clearly affecting decisions is the experience of management.

How many cycles has it lived through in its particular business? Has it been in the saddle only on upswings, or has it ridden through complete cycles? Perhaps at this point, it will be well to remember that selfishness is not necessarily the proper word to apply to management which attempts to maintain itself in the management position. If any of us are thrown into a stream, we are expected to paddle to keep our heads above water. If we refuse to paddle and allow.ourselves to sink, we are accused of suicide. It is not selfishness for us to swim. If we tried to push someone else under the water in order to save ourselves, then that becomes selfishness, but not just the effort to keep ourselves afloat. Management which does not govern its decisions in a way that will continue that management in power must either believe that it should be out of power, that is, show lack of confidence in itself, or be completely irrational, it would seem to me.

Management's sense of responsibility is a very real factor. Frequently, management is drawn in on a kind of hit and miss basis knowing that for the preservation and advancement of its own interest, it must take long chances. It cannot be expected to do otherwise. Decisions may then depend on the type of organization. If management is backed by an untried, young, aggressive organization, its decisions must be different from those it would make if backed by a well-rounded, time-tested organization on which management can depend without even worrying about it. A final internal factor is thus the type of board. A board completely dominated by management may produce a completely different result in management decisions from a board including some very strong personalities with


longer or different experience from that of management. We know that frequently management decisions on finance are made as part of a compromise with the board of directors in order to obtain other concessions from certain strong members of the board.

Then, there is another type of factor entirely apart from any of these we have discussed, and that is the type of company, and we speak of this in another sense than that used in the Jacoby-Weston paper. A company manufacturing a broad, diversified line may take a totally different attitude toward the publicity requirements of registration from a company manufacturing a single line, for the publicity involved in registration on a single-product company may give much more information than would be the case in a multiple-line company. The same would be true in the case of a single store instead of a chain-store.

Then, there is still another group of factors, and in this is included the type of advice available to management, and the closeness of management to its advisers. You may very properly accuse me of prejudice in my discussion of these factors. I believe that it is within the scope of proper investment banking to give all-round advice to corporations in relation to their financing problems. Investment banking firms should be equipped to do either public or private financing, and in any form available in the market. They should be able to give unprejudiced advice. The frustrating limitations placed on investment bankers by the various securities acts have forced many of them into the role simply of trader and market operators rather than that of the broader investment banking role. The discrediting attacks on investment bankers during the thirties, regardless of how well merited those attacks may have been, again have set up a barrier between the investment banker and his appropriate corporate client. The client who before 1932 was likely to come first to the investment banker and, at the proper time, be referred by him to lawyers, auditors, and commercial bankers, now is much more likely to meet and become acquainted with his auditor, his tax consultant, his lawyer or his commercial banker• before he comes in to his investment banker. And, no one of these can give well-rounded investment banking advice, nor can the institutional investor, the investment trust or the insurance company. Each of those men must recommend that type of financing which he is equipped to give, or must recommend financing out of a limited experience. No one of them can be an impartial adviser, trained in the field in which he is asked to give advice at this point.

Finally, most financial decisions are not made on any grand style. They are made as small decisions. The small decision makes us decide to expand. Perhaps we strain our working capital, and then replenish it with


commercial borrowing. Next, because our expansion is successful, we have to expand more. We see a chance to do some financing and do it, but the decisions are not major ones carefully taken with an eye to all factors involved, but rather small decisions, step by step, that begin to form a pattern which can be followed. Questions of building to save rent, of putting in some experimental machinery to cut costs, all of these things may make the major decisions small decisions when they are finally reached.

All of us who are God-fearing men are glad that this is so, because we believe man acts more wisely in making small decisions than he does in making great ones.

Discussion:DAN THROOP SMITH, Harvard University

The type of investigation proposed by Messrs. Jacoby and Weston should be very useful in developing, our understanding of the great diversity of practice in corporate financial policy even under seemingly similar conditions. Mr. Alexander remarked earlier on the wide spread around average figures which he had found in his own studies, noting the absence of any normal distribution or even of any significant modal value. I have been much impressed by the multiplicity of factors which may influence actual financial decisions and with the absence of any systematic method of even noting, not to mention weighting, these relevant points by business managements.

Theoretical and deductive analyses of business financing are subject to the great danger of oversimplification. The traditional presumption that maximization of income was the dominant objective may certainly be counted now as an example of oversimplification. Mr. Durand in his paper offers the concept of maximization of present value as the dominant objective, with a plan for a statistical determination of the increasing risk inherent in higher debt ratios. The idea of applying lower capitalization rates to future income subject to greater risk is a familiar and useful one, but by itself it would be nearly as great an oversimplification as 'the income maximization concept which it is apparently intended to replace.

The examinations of specific business situations contemplated by Messrs. Jacoby and Weston should do much to give us a more realistic understanding of the manner in which decisions are actually made. In making such studies, I suggest the advantage of intensive detailed examinations of a smaller number of situations in preference to a survey quesFACTORS INFLUENCING MANAGEMENTS tionnaire of a larger number of situations. Direct answers to a list of predetermined questions are not likely to provide full appreciation of the subtle attitudes and intuitive judgments which, along with logical reasoning, are involved in financial as well as other administrative policy decisions. Where several people participate in a joint action it is interesting to find that they often give entirely different explanations for it. Oversimplification, in fact, may exist in the interpretation of a simple situation as well as in generalizations about many situations. Enough discussion to get the points of view of those principally concerned seems a prerequisite for an adequate interpretation.

Since the chief advantage in the proposed studies, in my opinion, will come from the greater reality of our understanding of financial policy, 1 shall not comment on the lists of factors presented in the paper. A few points seem to be missing; others that are included will probably be inconsequential. I hope that those making the study will for some time regard it as developmental. It is not quite clear from the written paper whether the authors intend to try to develop their own systematic weighting of factors in order to provide a formula for determining ideal conduct, or to measure the relative importance of factors actually taken into account to provide a generalized description of present conduct on the basis of the sample covered. I should be highly skeptical of the possibility of attaining either of these possible objectives in the near future.

As regards a formula for guidance to management; the relative importance of the different relevant factors varies so greatly from situation to situation that any system of weighting, no matter how complex it was, might give inadequate recognition to an individual factor which should be dominant in a particular set of circumstances. The idea of a composite measure, or index of indices, was once popular in credit analysis, but it was found to obscure important critical facts: A composite index seems even less appropriate in the more complex problem of general financial policy. In the same way, a generalized description of the cases obtained would probably obscure the many significant differences which should be the principal result of the study. Patterns of behavior should become apparent; but a full description of the differences in action and attitudes would at this stage be a greater contribution than any attempt to describe diverse behavior in universal terms.

In the course of rather extensive inquiries during the past eighteen months on the effects of taxation on corporate financial policy, I have been trying to determine what significant patterns existed in certain types of decisions on financing. Perhaps a few of my tentative conclusions will be useful in indicating the need of broader studies.



It was quite promptly apparent that financial decisions were not simply based on maximizing income; even more importantly, they were very commonly not even based on the objective comparison of the relative costs of many different methods of financing. Rather, a management often seems to start with a strong predisposition in favor of some method or methods which are used unless they are prohibitively expensive. Also, certain other possible methods are not seriously considered. The dislike of debt, for example, is a very real force for many managements, so that any longterm debt is, in the most literal sense of the word, unthinkable. Some owner-management groups in smaller companies, on the other hand, are unwilling to have any public ownership of common stock. It is not unknown to have the form of financing determined by matters of pride; a less favorable available rate than that secured by leading competitors has turned decisions away from a choice of debt or preferred stock which would make the comparison conspicuous. These are among the real nonpecuniary motives.

Even systematic financial calculations do not seem to be carried on in any uniform manner. The cost of additional equity financing in an established company is not a concept on which there is a common understanding. Most frequently, in other than regulated companies, the dominant calculation seems to be that of the required return on new funds to maintain per share earnings. When stock is sold at less than the value per share of the assets at current market value, a sale of stock produces an increase in assets less than in proportion to the increase in shares outstanding. This is true even on the assumption of a continuation of whatever debt-equity ratio is considered normalfor the firm.' Earnings per share are thus reduced unless the rate of return on added assets is higher than that on existing assets stated at current market value; and even if this is the case, funds available through operations can be used for the proposed new outlays over a period of time. Internally available funds may be thought of as pre-empting the more profitable uses. The comparison between returned cost must be made, therefore, not with the best possible use of funds, but with what would be the marginal uses.

important in some companies that Cash budget considerations are the costs of new financing are projected in terms of cash drains. In one 'The point may be illustrated by a firm with $1,000 of book assets (currently worth $2,000), a debt of $500 and an equity of $500. If $100 of new equity is sold at book value, there is in this first instance a 20 percent increase in the equity interest against a 10 percent increase in book assets and a 5 percent increase in present market value of assets. Even if another $100 of assets is secured by an increase of debt to $600 (maintaining the debt-equity ratio) there is only a 10 percent increase in assets against the 20 percent increase in the claims against earnings.



large listed company, for example, preferred dividend requirements were compared with interest plus sinking requirements on a debenture issue (without reference to the fact that the sinking fund payments retired debt and were not an expense), and preferred stock was chosen because of its inherent advantage in view of the fact that it cost very little more in terms of cash.

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