The Theory of Corporate Finance: A Historical Overview

Our purpose is to provide a review of the development of the modern theory of corporate finance. Through the early 1950s the finance literature consisted in large part of ad hoc theories. Dewing (1919; 1953) the major corporate finance textbook for a generation, contains much institutional detail but little systematic analysis. It starts with the birth of a corporation and follows it through various policy decisions to its death (bankruptcy). Corporate financial theory prior to the 1950s was riddled with logical inconsistencies and was almost totally prescriptive, that is, normatively oriented. The major concerns of the field were optimal investment, financing, and dividend policies, but little consideration was given to the effect on these policies of individual incentives, or to the nature of equilibrium in financial markets. The logical structure of decision-making implies that better answers to normative questions are likely to occur when the decision maker has a richer set of positive theories that provide a better understanding of the consequences of his or her choices. This important relation between normative and positive theories often goes unrecognized. Purposeful decisions cannot be made without the explicit or implicit use of positive theories. You cannot decide what action to take an