Why financial economics cannot explain financial management

Tiago Cardao-Pito

International Review of Financial Analysis, 2025, vol. 106, issue C

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.

Keywords: Mechanical effect hypothesis; Informational content of prices hypothesis; Capital structure; Market-to-book; Capital-income theory; Growth; Intangible assets (search for similar items in EconPapers)
JEL-codes: A10 B40 C10 C50 D20 D40 F30 G10 G30 L10 L20 M20 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:106:y:2025:i:c:s1057521925006453

DOI: 10.1016/j.irfa.2025.104558

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