A Book Review – 'The Theory of Corporate Finance' by Jean Tirole

It took me a while to get my fingers on this Princeton University Press book. I was a bit anxious, since this corporate study textbook (published summer 2009) has already become quite well known in the academic environment. It is used as a study text by many universities and it can be cited as a different approach on the already over-published field of the super-trooper and sophisticated corporate management of finances.
If you are a seasoned professional working in corporate finance or as investment analyst, it is very probable that you've them all. This means that you saw the CFA (Chartered Financial Analyst) -endorsed books, such as the famous Investments by Bodie and Kane. You probably saw also the stock market analysts’ books – those written by the guys or girls who have been very successful as investor managers. You also probably saw the books written by various academics in the field of finance. So probably right now your head is spinning at the mere invocation of all these names and handbooks.

If this is the case, you've probably noticed that much of the information is repeated. You can find the same topic in various shapes and sizes coming to you and waiting to be served in various shapes and with changed examples. Take, for example, the dividend payout theory – we all know that a company should pay a dividend as long as the expected outcomes of the company’s actions are less than the cost of capital. With examples,etc etc.

Well, The Theory of Corporate Finance by Jean Tirole claims to be different.

The Theory of Corporate Finance book takes off by laying out the foundation. An overview of the corporate institutions gives Tirole the occasion to show off a bit and offer us a cold view on the main governance issues faced by the today’s big corporations. Then it goes deeper, on the social contract which binds the corporations and their financiers – shareholders, bondholders, banks or other stakeholders. But this is just the beginning. The Theory of Corporate Finance starts slowly by building your awareness of various financial instruments which a corporation uses. Then it goes through the famous agent theory, which by definition states that the owners of the company appoint agents (in the form of the Board of Directors) to run their company.

And this is just the start. The book it is very well written, in the sense that it offers a practical twist to almost any corporate finance aspect. For example, in Chapter 5 (Liquidity and Risk Management, Free Cash Flow, and Long-Term Finance) there is a sub-chapter where Tirole reflects on “Endogenous Liquidity Needs, the Sensitivity of Investment to Cash Flow, and the Soft Budget Constraint”. Basically, here the author shows that the cash flow decisions are very similar to the ones taken under the “real options” assumptions. The cash flow decisions are made in a real world with imperfect data, so the corporate decision makers have to choose among various alternatives which by themselves are not perfect. I liked a lot the chapter called “Product Markets and Earnings Manipulations.” In a sense, most CFOs are tempted at least once in their careers to do a bit of “window dressing” for the results of their companies.

Therefore, even if you are an outside investor in the modern corporations, The Theory of Corporate Finance might be a good read. It teaches you to perform a thorough and realistic fundamental analysis on a stock-exchange listed corporation. Tirole shows you the basic factors that impact on the financial performance of a corporation. And, even more important, Tirole's book demonstrates how these performance indicators affect the financial behavior of the companies.

Given the fast and big advances made by corporate finance in the last decades, it is important to have such a book in your library, at least for reference. It is even more important if you are an investor, since most of the financial data is now readily available via the internet. Anyone can get a set of financial statements and run a set of indicators on these. The question is – “what conclusions can you draw from this analysis?”

Comments

[Shaftsinker:]

great comments

Nov 14 08:33 AM

[Boaz Berkowitz:]

Sounds like a good read, thanks.

Nov 18 07:21 AM