Theory, Models and Implementation in Financial Management

A theory of corporate financial management is summarized from the broad flow of finance literature. Within this, contributions to a normative theory, amenable to corporate financial modeling, are reviewed in some detail. The central propositions of a normative theory are isolated to provide a basis of comparison for the practice of financial modeling, as observed through a field research study. Differences between theory and practice are identified and discussed. Compared with the experience of ten years ago, computer-based financial modeling systems are today gaining much greater acceptance in business organizations. Despite this, a wide gap seems to exist between the information and logic structures programmed into financial models, and the precepts and algorithms derived from a normative theory of corporate financial management. Implementation difficulties in three main, but interdependent, areas are identified as causing the gap between theory and practice. First, there is the difficulty of constructing relevant information in a form which would be meaningful in a normative framework. Within the braod set of managerial activities of an organization, there are several relevant logic structures, including: a financial accounting structure; an economic structure dealing with cash flow, economic value, and marginal rates of return to investment: operating information structures dealing with the conduct of an organization's work; and strategic information structures dealing with an assessment of the external and internal human needs which provide a rationale for an organization's present and future existence. The systematic provision of information in each logical mode, and the translation between modes, poses a considerable intellectual and practical challenge. Then there is the problem of dealing satisfactorily with strategic uncertainty, and the way that uncertainty is distributed within the managerial organization. Finally, multiple and conflicting goal dimensions pose considerable problems in terms of an explicit modeling of a corporate objective function. Beyond the intellectual difficulties, moreover, there are political dimensions which cause a reluctance to address an objective function explicitly and directly. Normative finance theory provides a powerful logic for designing information and decision-making structures to support corporate planning. At present, however, the research reported in this survey paper suggests that the finance model is incomplete, particularly with regard to inclusion of behavioral and political dimensions of organizational processes under uncertainty. Finally, the reader should be forewarned that the literatures referenced in this survey are somewhat disjoint, involving different concepts, language and paradigms. This means that the paper's jargon level to most readers will remain high, even after the authors' attempts to minimize it.