The theory of business enterprise and Veblen's neglected theory of corporation finance.

Author:Ganley, William T.

As the twenty-first century began, the neoclassical models of economics and finance appeared to have inadequate explanations for the stagnancy of financial markets. Theorists turned to the historically dependent bubble models to analyze and explain the collapse of the U.S. stock market in 2000 and its stagnation for the next several years. The collapse was accompanied by news of financial fraud, the corruption of accounting standards, pie-in-the-sky profit projections, and the flow of false financial information. The tendency to treat each case as an aberration from standard finance lost much of its appeal. Yet, if we turned back a hundred years to Thorstein Veblen's The Theory of Business Enterprise we would find an interesting and robust analysis of present-day corporation finance.

This paper will start with an overview of Veblen's theory of corporation finance. Next I will survey the reviews of his analysis in the history of economic thought. Then, a comparison of Veblen's model with the Fisherian model, which eventually became the foundation of the neoclassical theory of capital, will be presented. The applicability of Veblen's financial concepts to present-day corporate financial management will be assessed. Finally, the paper will evaluate the potential of Veblen's theory of corporation finance as an alternative to the current standard model.

Veblen's Corporation Finance

Thorstein Veblen's construction of a theory of corporation finance was intended as a major building block in a theoretical explanation of business behavior and the cyclical movement of industrial economies. The theory was developed in The Theory of Business Enterprise ([1904] 1978) and expanded in later works, especially Absentee Ownership ([1923] 1964). His critiques of Irving Fisher's theory of capital and interest supplemented his approach to corporation finance ([1908] 1996, [1909] 1996). In this paper I will concentrate primarily on his original model in Enterprise, where the theory was spelled out in detail. The relevance for today's world of corporate finance was his focus on large-scale, multifaceted businesses, especially those that grew through mergers and acquisitions.

According to Veblen the giant corporations of the late nineteenth and early twentieth centuries were not primarily interested in profit maximization through the production and sale of products. The primary goal of the corporate managers of such companies was to maximize the value of their common stock. Veblen put corporation finance as the centerpiece of his analysis of large, acquisition-minded companies. In Veblen's analysis, the corporate finance structure was capitalized on the earnings capacity of the corporation as a going concern ([1904] 1978, 137). The capital of the company included not only its material capital but also its immaterial or intangible capital, measured by goodwill. This was one of the criticisms Veblen made about Fisher's theory of capital. He argued that Fisher erroneously excluded immaterial capital from his definition of capital (Veblen [1908] 1996, 154).

Veblen believed economics had to follow the actual practices of business in order to construct a theory of economic activity. Businessmen knew what capital was, and their usage of the term should guide economists (Veblen [1904] 1978, 151). Immaterial capital was as important as physical capital in business decision making. Business often treated intangible assets, or immaterial capital, as goodwill. Goodwill could often be identified with very specific corporate property, such as patents, trademarks, brand names, or exclusive use of special processes protected by law. However, it also included established business relations, reputation for business transactions, and processes protected by secrecy (Veblen [1904] 1978, 138-139). A more general sense of goodwill could go far beyond these matters to include almost any potential for growth the firm could create for itself as a business entity. In the end, for Veblen "the substantial foundation of the industrial corporation is its immaterial assets" ([1904] 1978, 143).

Corporate management had...

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