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

If you are a seasoned professional working in corporate finance or as investments analyst, it is very probable that you saw them all. This means that you saw the CFA (Chartered Financial Analyst) endorsed books, such as the US 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 only at the invocation of all these names and handbooks.

If this is the case, you 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. And examples follow etc etc.

Well, “The Theory of Corporate Finance” by Jean Tirole claims to be different. Before hand, it claims to be comprehensive. Yet, I read so many comprehensive finance books, that I don’t even remember what should one contain. Well, I was a bit skeptical. “The Theory of Corporate Finance” is indeed quite comprehensive. And it is not comprehensive in a bad way – on contrary. The book is very well organized – it actually manages to bring out the logic of the corporate finance. It even explains through its summary why the corporate finance field developed as such historically. Which, for a guy like me, passionate about finance, it is quite nice.

The “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 on 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 Theory of Corporate Finance” as a book it is very well written, in a sense that it offers a practical twist to almost any corporate finance aspect. For example, in the 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 7 called “Product Markets and Earnings Manipulations.” In a sense, most CFO’s 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 lecture. 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, “The Theory of Corporate Finance” demonstrates how these performance indicators affect the financial behavior of the companies.

Given the fast and big advancements taken by the corporate finance in the last decades, it is important to have such a book in your library, at least for references. 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?” “The Theory of Corporate Finance” might help you to answer these questions faster and more accurate.

 

As you can see, I tried to do this review impartially (not as a commercial). Should you like to read the book, please try this Amazon link – you will pay the same price whilst a small referral fee will help sustain this investment blog. Thank you for your choice!:

 

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