Finance Theory And Financial Strategy

Essay by PaperNerd ContributorUniversity, Master's February 2002

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Article Review; Finance Theory And Financial Strategy (Myers) The article Finance Theory and Financial Strategy by S. Myers provided and interesting perspective on the relationship between finance theory and financial strategy. In essence he attempts to answer the question as to why managers do not use theory in strategic planning.

The article addresses a gap between theory and strategy. Myers states three reasons why this gap exists. First, it's due to differences in language and "culture"�. Second, it's the misuse of finance and hence not accepted in the strategic formula. And third, it is a result of a failed discounted cash flow analysis. (Myers) This gap is most apparent when a firms strategic goals and financial goals are in conflict. This appears as managements concern for EPS while implementing strategic maneuvers. This ultimately is a short-term vs. long-term approach conflict among and within managers.

The gap could be described as a cultural problem.

Needing only additional communication to suffice. As both financial and strategic analyses are subject to error. One might expect a checks and balances system in place whereby the financial is checked by the strategic and the converse. For example, during a strategic analysis one would expect a process of double-checking, with a NPV calculation, to be demonstrated. Unfortunately this is rarely accomplished.

The misuse of finance theory is also a contributing factor to the gap between finance theory and financial strategy. Typical errors made in computing DCF create a situation favoring short-term projects. For example, internal projects are compared by their internal rate of return and not NPV, inconsistent treatment of inflation while computing DFC, and using unrealistic high discount rates. With this said it appears that managers may not truly understand what it takes to make a dependable DFC analysis.

And lastly, the gap between...