Why financial economics cannot explain financial management

Abstract

Financial economics generally claims that financial management is either irrelevant or relevant merely because of supposed market imperfections. This study presents an alternative explanation: ‘in our monetary societies financial management is a significant activity for organizations, societies, and the human-relationship with the biosphere’. Accordingly, it discusses two hypotheses with excess content in relation to the Fisher-Modigliani-Miller capital-income theory, which is the cornerstone of capital-structure management theories in financial economics (e.g., trade-off theory, pecking-order theory, and market-timing theory). The first mechanical-effect hypothesis suggests that the empirical relationship between the market-to-book value of a firm (or Tobin-q) and its capital structure is not due to the market's ability to identify intangible assets and growth opportunities, but rather because of the market-to-book variable's computational procedure. We add a new hypothesis, namely, that for computational reasons, the empirical behavior of the market-to-book of the firm and market-to-book of equity is only similar when both variables are close to or equal to 1. We tested conventional and big data methods on large samples of firms from eight-countries. The findings demonstrate the unsustainability of financial economics in explaining real-life organizations, societies, and environmental phenomena. Hence, we contribute theoretical and empirical support for research on alternative explanations.