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H-NET BOOK REVIEW 
 
Published by [log in to unmask] (July, 1997) 
 
Jonathan B. Baskin and Paul J. Miranti, Jr. _A History of 
Corporate Finance_. New York: Cambridge University Press, 1997. x 
+ 350 pp. Tables, epilogue, appendices, notes, and index. $29.95 
(cloth), ISBN 0-521-55514-0. 
 
Reviewed for H-Business by Robert E. Wright, Temple University 
<[log in to unmask]> 
 
   The Alleged Poverty of Positivism and the Modern Theory of 
Finance 
 
_A History of Corporate Finance_ is a solid contribution to 
scholarship that should gain the interest of historians, lawyers, 
economists, and business persons. Its unusual combination of 
scope, clarity, and brevity, combined with its reasonable price, 
may induce professors to make it required reading for advanced 
undergraduate and graduate courses in economic or business 
history, or in management education courses. Highly interpretive, 
the book is more a work of synthesis than of original research in 
primary sources. At 350 pages, the book is hardly comprehensive, 
but it nevertheless manages to tie much temporally disparate 
material into its thesis. 
 
That thesis the authors lay out carefully in the introduction, 
"History and the Modern Theory of Finance." Citing Keynes and 
Schumpeter, Jonathan Baskin and Paul Miranti remind readers of 
the "complementary" nature of history and finance and announce 
their intention to employ "historical methods to amplify an 
important contemporary paradigm" (pp. 1-2). That paradigm, the 
"modern theory of finance," seeks to evaluate the "financing 
question" (optimal capital structure decisions), and the 
"dividend question" (distribution of income to shareholders). The 
early leaders of modern finance theory were Franco Modigliani and 
Merton H. Miller. Based on an abstract model, they argued that 
"firms cannot increase value by issuing either debt or equity" 
and that "managerial decisions are irrelevant" (p. 16). 
Questioning conclusions based on what they consider to be 
ungrounded, formalized models, Baskin and Miranti argue that the 
modern theory of finance needs to take greater recognition of 
"path dependence and historical evolution" (p. 3). To 
substantiate their view, they describe the intellectual history 
of economics (economiography?) since the diffusion of Karl 
Popper's "falsifiability" philosophy of science, and, at the end 
of each chapter, they test the assumptions and real-world 
applicability of theoretical models. Generally, they find the 
abstractions empirically deficient, and thus call into question 
"the profession's current infatuation with models that lend 
themselves to formal mathematical explication" (p. 23). 
 
Divided into three parts, "The Preindustrial World," "The Rise of 
Modern Industry," and "The Transition to the Contemporary Era," 
the main body of the work opens with a discussion of medieval and 
renaissance finance. After a brief description of the medieval 
commercial revival, Florentine and Venetian finance is treated at 
some length with emphasis on enterprise organization. The authors 
conclude, not surprisingly, that "other factors than those 
considered in the modern theory as laid down by Modigliani, 
Miller and others had been foremost in defining early financial 
institutions" (p. 51). 
 
Corporate finance in the age of global exploration, especially 
the rise of joint-stock trading companies like the East India 
Company, forms the basis of chapter 2. Baskin and Miranti 
conclude that the "pecking order" hypothesis of Gordon Donaldson, 
"the traditional explanation of funding decisions prior to Miller 
and Modigliani," best explains the East India Company's financial 
decisions (pp. 22, 84). Donaldson's hypothesis predicts 
organizations will finance operations first from retained 
earnings, then from debt, and lastly from the sale of additional 
equity.  With debt interest rates lower than equity returns, 
business cycles violent, and the probability of losing control of 
the company in an equity expansion high, East India Company 
managers borrowed capital with short-term debentures. 
 
Chapter 3 takes up the emergence of public markets for investment 
securities from the Glorious Revolution to the final defeat of 
Napoleon. Predictably, the Bank of England, John Law, and the South Sea 
Bubble are the major subjects covered, but an interesting twist, 
the notion that the "watershed of 1720" caused British and French 
financial development to diverge markedly, enlivens the 
discussion. If true that France turned "antitrade and antimarket" 
after the "Law fiasco," the authors have hit upon a major 
explanation for the Anglo-American victory in the struggle to 
control North America (French and Indian War [1755-1764] or Seven 
Years' War [1756-1763]) and an important cause of the French 
Revolution (p. 114). In any event, Baskin and Miranti's main goal 
in the chapter is again to attack the modern theory of finance by 
pointing to the "high risk in economic affairs and poor 
information" facing eighteenth-century investors. In that 
environment, low-risk government debt was a more attractive 
investment option than equities (p. 122). 
 
The problems involved in accurately valuing equities persisted 
into the nineteenth century, the age of massive infrastructure 
improvements. With particular emphasis on canal and railroad 
corporations, the authors describe the evolution of preferred 
stock, a hybrid between debt and equity financing. Preferred 
stock paid a guaranteed dividend, but conferred no voting 
privileges, thereby allowing managers to maintain control over 
the corporation. Also, unlike bond payments, dividend payments 
could be suspended without forcing the corporation into 
receivership. The creation of preferred stock, the authors 
believe, supports the "pecking order hypothesis" more than the 
modern finance theory. By incorporating the fixed-income and 
non-voting characteristics of debt instruments into a hybrid 
equity form, managers transcended some of the limitations of the 
pure debt market and staved off the flotation of true equities. 
 
After 1900, the authors admit in the next chapter, a broad, 
impersonal market in common stock arose in both Britain and the 
United States. Managers, however, continued to prefer retained 
earnings, fixed debt, and preferred stock over the flotation of 
common stocks. The main body of the book concludes with two long 
chapters of in-depth analysis of the financing of center firms, 
conglomerates, and leveraged-buyout partnerships. Not 
surprisingly, the pecking order hypothesis again emerges as the 
key means of understanding successful corporate financing 
strategies. By downplaying the successful initial phase of the 
post-1960s merger movements, the authors portray conglomerates 
and LBOs as failures inspired by the over-simplistic models of 
academics. For instance, they label Henry G. Manne's contract 
theory "underspecified" because it fails to account for the 
effects of government regulation and the importance of manager 
tenure (p. 287).  However, Baskin and Miranti admit that although 
the pecking order hypothesis generally "predicts the progression of 
corporate financial preferences, it does not provide guidance 
with respect to either the relative weight placed on these 
alternative sources or the rates at which this process 
progressed" (p. 297). 
 
The basis of _A History of Corporate Finance_ is Baskin's 
dissertation and 1988 _Business History Review_ article, "The 
Development of Corporate Financial Markets in Britain and the 
United States, 1600-1914: Overcoming Asymmetric Information." 
Baskin died before completing revisions, but Paul Fink, Baskin's 
father, arranged for Miranti to bring his son's contribution "to 
fruition" (p. ix). Probably because of the difficulties of 
editing a half-posthumous piece, the book suffers, in places, 
from an over-rigid style, poor balance, and uneven organization. 
Over one-half of the book, for instance, covers the twentieth 
century. 
 
Also, the epilogue and two appendices seem out of place. The 
former reads like a conclusion except for the formulation of an 
original algorithm that purports to explain the relationship 
between short-term, firm-specific factors and long-term 
environmental elements in financial development. If truly 
significant, the algorithm should be explained in the 
introduction and applied throughout the narrative. Appendix A, a 
short description of finance and informational asymmetries in the 
ancient world, rightfully belongs in chapter 1. Appendix B, 
"International Patterns of Corporate Governance," contrasts 
Anglo-American financial markets with their equivalents in Japan 
and Germany. The main contention is that, because of its 
transmission of "reliable information" to investors, the 
Anglo-American financial system is more efficient and conducive 
of economic growth than the "opaque regimes of Japan and Germany" 
(p. 322). 
 
Although probably correct and extremely interesting, the 
presentation is _ad hoc_ and, at 8 pages, too truncated to be 
entirely convincing. I hope that Miranti will take up a broad, 
comparative study of financial institutions since the late 
nineteenth century as his next major project. 
 
Although an outstanding study that will deservedly gain a wide 
audience, the book ultimately fails to reconcile the methods and 
outlook of history with those of economics. The belated algorithm 
is a step in the right direction, but still short of creating 
realistic (adequately specified) models that can be 
quantitatively tested. Though it is true that some past models 
have been unrealistic in some regards, nothing in this book will 
convince economists to abandon formal, mathematical theorizing. 
Baskin and Miranti, in other words, have rightly called the 
modern theory of finance into question, but have not set forth a 
completely viable alternative. 
 
 
Copyright (c) 1997 by EH.Net and H-Net, all rights reserved.  This work 
may be copied for non-profit educational use if proper credit is given to 
the author and the list.  For other permission, please contact 
[log in to unmask] (Robert Whaples, Book Review Editor, EH.Net. 
Telephone: 910-758-4916. Fax: 910-758-6028.) 
 
 
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