My Review of Donald Chew Jr.'s "The Making of Modern Corporate Finance"

An Ode to Modern Financial Theory

As a former professor of finance, I read Donald Chew’s book with great interest. His book is a history of the development of modern financial theory from its early roots in John Burr Williams’ 1938 “Theory of Investment Value” to its beginning in the late 1950’s with the works of Miller and Modigliani on capital structure and dividend irrelevance. He made a mistake in attributing Myron Gordon’s model to Williams. 

Chew writes in a very breezy style by referring to Michael Jensen as Mike and Stewart Myers as Stu. From his post as an editor of Stern Stewart’s “The Journal of Applied Corporate Finance,” he got to know most of the major players in academic finance. I too met many of the academics he discusses, and indeed I was an early adopter of Brealey and Myers textbook he highly praises in my corporate finance class during the 1982-83 academic year. I also met, on several occasions, his mentor, Joel Stern.

Chew makes the case that earnings per share don’t count, but rather it is the ability of a corporation to earn a return above the cost of capital with return measured as net operating profit after taxes. It is with this insight that Stern Stewart pioneered the concept of economic value added. (EVA) Indeed, instead of using earnings to value a corporation, value can be defined as the present value of the cash flow associated with existing assets plus the present value of future growth opportunities. Hence, Amazon for example, can trade at values divorced from current earnings.

However, he oversells his point that earning per share doesn’t count. Corporate management and analysts continue to stress earnings per share and woe to the company that misses its quarterly earning estimates.  In the short run earnings seem to count a great deal.

He also oversells private equity. To be sure private equity posted extraordinary returns in its first twenty years starting in the 1980’s. Since then, returns have eroded, and their risks have been underrated. Put simply, the industry is guilty of what Cliff Asness of AQR, calls “volatility washing.”

This book is of interest to readers who are interested in how modern financial theory evolved and it is helpful in understanding what forces drive stock prices in long run.

 

My Amazon Review of Binyamin Appelbaum's "The Economists' Hour: False Prophets, Free Markets and the Fracture of Society"

Economists in the Crosshairs

I have to admit at the outset that I am a card carrying financial economist and know or knew several of the economists mentioned in the book. New York Times editorial writer and former economics reporter Binyamin Appelbaum has written a screed blaming the Chicago School of economics for the vast increase in economic inequality since 1973. Trust me he gives them way too much blame/credit because the amorphous forces of globalization and technology have done far more to create the winner take all society we seem to be living with.

He basically argues that the economics profession staged a hostile takeover of Washington politics. The profession rises from the bowels of the Fed to the near stardom of CEA Chairman Walter Heller in the Kennedy White House. It was the heyday of Keynesian economics as the Kennedy-Johnson tax cuts engendered the mid-1960s boom. It was the failure of Keynesian economics to predict that inflation and unemployment could exist side-by-side that opened the way for the Chicago School. He specifically signals out Milton Friedman, Arnold Harberger, Richard Posner and Michael Jensen among others as his villains.

Appelbaum really doesn’t understand how the 1970s inflation unhinged society. For most American the economy seemed to be out of control and he doesn’t note that the tight bracket unindexed income tax system confiscated the real wages of the American people. Thus although pre-tax wages rose faster than inflation; after-tax they did not. Thus to me Fed Chairman Paul Volcker was a hero.

His careful research shows up in his discussion of how the draft ended under the impetus of Nixon aide Martin Anderson, the intellectual arguments of Milton Friedman and the strong technical work of Walter Oi. He also discusses the role of dissent in the armed forces by highlighting an anti-war demonstration that took place in Fayetteville, North Carolina adjacent to Fort Bragg where actress Jane Fonda spoke. I attended that demonstration. He showed real diligence in coming with the source for this event in an unpublished Duke Ph.D. dissertation written by air force colonel Scoville Currin.

Appelbaum has mixed feelings about the volunteer army, but I suspect that if the United States had a draft after 9/11 he would be far less ambivalent. In 2001 Appelbaum would have been 23 years old and I just can’t picture him taking mortar fire in the Hindu Kush Mountains of Afghanistan or being face down in the mud on the banks of the Tigris River in Iraq.

He devotes a chapter to the role of the “Chicago boys” in the 1970s Pinochet dictatorship of Chile. There Chicago trained economists’ orchestrated policy of the regime. To Appelbaum their policies weren’t all that successful, but he stopped the clock in 1990. He doesn’t really speculate on what would have happened if assassinated socialist Chilean president Salvatore Allende remained in power. It could very well turned out be a facsimile of the Chavez/Maduro hell in Venezuela instead of it being the thriving country that it is today.

Appelbaum rightly notes that the Reagan deregulation of the 1980s had its origin under Jimmy Carter. Where under the Senate leadership of Edward Kennedy and with the backing of Ralph Nader both the airline and trucking industries were deregulated. Here the economist in charge was Alfred Kahn. We can thank him for cheaper airfares and the hassles of flying today.

In his obsession to blame economists for inequality Appelbaum also leaves out the massive failure of all too many urban and rural public schools. If anything most economists are on the side of the angels in attempting to improve public education. Further he fails to mention that for all practical purposes the Democratic Party abandoned American workers for the siren calls of identity politics.

Appelbaum has written a very readable book. Unfortunately he way over-states his case. He should have been more modest. By the way that is the same advice I give to my economist colleagues. His personal vignettes about the economists he discusses are terrific and unlike most books, read his footnotes. There are loads of interesting kernels there.

For the full Amazon URL see: https://www.amazon.com/review/R2TASSYK4EXXP4/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Duff McDonald's "The Golden Passport: Harvard Business School, The Limits of Capitalism, and the Moral Failure of the MBA Elite"

Put the Blame on HBS

Duff McDonald has written a very long (672 pages in the print edition) minutia filled anti-American business and anti-Harvard Business School screed. For the most part he believes that American business can’t do almost anything right and he places the blame on the “West Point of Capitalism,” the Harvard Business School for practically everything that is wrong with America.

He doesn’t like the managerial capitalism of the 1950s that ran aground in the 1970s and the shareholder capitalism that began to evolve in the 1980s. What he would prefer is some broad version of “stakeholder” capitalism that protects the environment and combats income inequality, but my question is whether business is the vehicle to do that. My guess is that if business tried as it did minimally in the late 1960s he would use the leftist pejorative term “corporate liberalism.”

The villain of his piece is finance professor Michael Jensen who laid the intellectual foundations for shareholder capitalism in the late 1970s. Out of this flows leveraged buyouts, mass layoffs and the philosophy of short-termism with respect to the undo focus of corporate management on meeting quarterly earnings expectations. He however conveniently ignores such successful corporations as Amazon, Google and Berkshire-Hathaway who invested for the long run and mightily succeeded.

McDonald is highly critical of HBS’ case method of instruction which by its very nature lacks real theoretical underpinnings. That is true, but the case method is useful in organizing how to think about very real business problems. It also leads to superb teaching. He admits that pretty much every professor at HBS is a great teacher, a skill that is lacking at other business schools.

He does favorably mention Harvard professor General Georges Doroit who was an expert on logistics and went on to found the venture capital industry in the early 1950s with his American Research and Development. He also singles out for praise Arthur Rock who was one of the earliest venture capitalists in Silicon Valley.

In the interests of full disclosure I have an MBA, not from Harvard, and taught MBAs. As a professor I used discussion of formal finance theory with an occasional case study in corporate finance. Indeed in the most case intensive course I taught, I so inspired one student that many years later he endowed a teaching award in my name. As a result it is hard for me to get too worked up about McDonald’s criticism of the case method.

With McDonald continually in the attack mode his book makes for a very difficult read so I would recommend readers to find better things to do with their time.  

The full Amazon URL is:

https://www.amazon.com/review/R1H3VHOMZUQ6XK/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv