The Traditional Phase:This phase has lasted for about four decades. Its finest expression was shown in the scholarly work of Arthur S. Dewing, in his book tilted the Financial Policy of Corporation in 1920s. In this phase the focus of financial management was on four selected aspects. It treats the entire subject of finance from the outsider’s point of view (investment banks, lenders, other) rather than the financial decision maker in the firm. It places much importance of corporation finance and too little on the financing problems of non-corporate enterprises.
The sequence of treatment was on certain episodic events like formation, issuance of capital, major expansion, merger, reorganization and liquidation during the life cycle of an enterprise. It laid heavy emphasis on long-term financing, institutions, instruments, procedures used in capital markets and legal aspects of financial events. That is, it lacks emphasis on the problems of working capital management. It was criticized throughout the period of its dominance, but the criticism is based on matters of treatment and emphasis.
Traditional phase was only outsiders looking approach, over emphasis on episodic events and lack of importance to day-to-day problems. The Transition Phase: It began in the early 1940’s and continued through the early 1950’s. The nature of financial management in this phase is almost similar to that of the earlier phase, but more emphasis is given to the day-to-day (working capital) problems faced by the finance managers. Capital budgeting techniques were developed in this phase. Much more details of this phase is given in the book titled Essays on Business Finance.
The Modem Phase: It began in the mid 1950’s and has shown commendable development with combination of ideas from economic and statistics has led the financial management to be more analytical and quantitative. The main issue of this phase is rational matching of funds to their uses, which leads to the maximization of shareholders’ wealth. This phase witnessed significant developments. The area of advancement was – capital structure. The study says the cost of capital and capital structure is independent in nature.
Dividend policy, suggests that there is the effect of dividend policy on the value of the firm. This phase has also seen one of the first applications of linear programming. For estimation of opportunity cost of funds, multiple rates of return-gives way to calculate multiple rates of a project. Investment decision under conditions of uncertainty gives the formula for determination of expected cash inflows and variance of net present value of project and also defined how probabilistic information helps the firm to optimize investment decisions involving risk.
Portfolio analysis gives the idea for the allocation of a fixed sum of money among the available investment securities. Capital Asset Pricing Model (CAPM), suggests that some of the risks in investments can be neutralized by holding a diversified portfolio of securities. Arbitrage Pricing Model (APM), argued that the expected return must be related to risk in such a way, that no single investor could create unlimited wealth through arbitrage. CAPM is still widely used in the real world, but APM is slowly gaining momentum.
The Agency theory emphasizes the role of financial contracts in creating and controlling agency problems. Option Pricing Theory (OPT), applied Martingale pricing principle to the pricing of real estates. The cash management of models (working capital management) by Baumol Model, Miller and Orglers, Baumol models helps to determine optimum cash conversion size; Miller model reorder points and upper control points and Orglers model helps to determine optimal cash management strategy by adoption of linear programming application.
Further new means of raising finance with the introduction of new capital market instruments, such as Pads, Fads, PSBs and Caps, etc. Financial engineering that involves the design, development and the implementation of innovative financial instruments, and formulation of creative optional solutions to problems in finance. Even though, the above mentioned developed areas of finance is remarkable, but understanding the international dimension of corporate finance formed a very small part of it, which is not sufficient in this era of globalization.