Sense and Nonsense in Corporate Finance

Louis Lowenstein, a former corporate chief executive who became a Columbia law professor, attacks the assumptions underlying much of 1980s corporate finance practice and academic theory. His targets are the efficient market hypothesis as applied to corporate decisions, the takeover boom, the use of accounting earnings as a management objective, and the transaction-driven advice supplied by investment banks.

His argument is that markets price securities on short-horizon information and that managers who take the price as a verdict on their decisions will systematically underinvest. He examines the leveraged buyout wave and argues that a substantial part of the gains came from tax deductibility of interest, from wage and pension reductions, and from underpriced targets rather than from operating improvement. He is critical of the academic finance literature for using event studies over short windows, which he argues measures market reaction rather than value creation.

He also covers accounting, arguing that reported earnings can be managed sufficiently to make earnings-based compensation and valuation unreliable, and that cash flow analysis and balance sheet examination are what a serious investor or director should use.

The book is argued from a position and Lowenstein is combative about the finance profession. Its specific institutional detail is from the late 1980s and is dated, and several of his empirical claims about buyout returns were contested at the time and have been partially superseded by better data. The scepticism about short-window event studies and about earnings as an objective has held up well.