In this discussion, I will first discuss the narrative of the ancient financial approach and compare it to the current economic approach according to the debate readings. I will present a classic financial theory that has greatly influenced contemporary monetary theory with a vivid and realistic example.
Old Financial Approach:
According to (Archer and D' AmbrD'io, 1969, p.20), the prevailing trend in the early twentieth century was financial management, which is concerned with the main aspects of the continuation of the business of companies, such as the movement of buying and selling and the collection of profits, away from the interest in the administrative structure and the distribution of roles, this was due to the emergence of industrial movements and the establishment of railways to interest in the structuring of capital, this led to the emergence of industrial conglomerates and the merger of companies and the monopoly movements prevalent at this time.
Contemporary Financial Approach:
According to (Saito & Savoia & Fama, 2013), the current trend is to focus on financial risk management, such as clearing and credit risks, transparency, governance, social responsibility, and sustainability. Finally, the focus of this discussion is the interest in creating more excellent value for the companies offered for trading.
Modigliani–Miller theorem (Classical):
According to (Brusov, Filatova, Orekhova, N., & Eskindarov, 2018), this theory of 1958 is one of the most essential classical theories that have directly influenced contemporary theory until the present time; they invented this theory new concept which they earned the Nobel Prize in Economics in 1985 and in 1990, respectively, for both of them. The idea is that "the value of companies is completely independent of their capital structure." It does not mean that a company has more financial assets than it has; instead, the opposite is true, as there are companies that have fewer financial assets, and their v, value is much greater than companies that have more significant financial investments.
Rational Expectations Theory (Contemporary)
Although this theory was initially formulated by "John F" Muth (1961)", "because of the many developments that have been made to it, it is considered a contemporary theory that is closely related to Modigliani-Miller theorem; the theory is that the financial value of companies and stocks can be guessed from the available information and past experiences of what profits could be in the future, for example, if people expect that a company has a better future, this will lead to an increase in its market value, regardless of its assets at the present time (McCallum, 1980).
Realistic Example:
According to (Liu, 2021), In 2021 Tesla'sTesla's value crossed the trillion dollar mark; at this time, the total market value of all the car companies offered for trading was less than this figure, including Toyota, the most prominent car production company in the world, whether in the assets it owns or in the number of cars it produces annually. Still, Tesla surpassed that because of the prevailing expectation of Tesla in the future. However, it has yet to achieve the profits achieved by Toyota or even close to it.
Conclusion
Although Rational Expectations Theory makes some small and start-up companies billionaires, this results from anticipating future profits and their ability to compete. Still, this theory may sometimes fail due to neglecting the operational capabilities of these companies and not taking them into account; for example, according to (Yahoo Finance, 2022), Swvl Bus Company was valued at $1 billion in 2021 and collapsed after one year to only $85 million, this is due to neglecting to look at the bad operational aspects of the company.
References
Archer, S. H. And D’Ambrosio, E.C. (1969). Administração financeira: teoria e aplicação. São Paulo: Atlas
Brusov, P., Filatova, T., Orekhova, N., & Eskindarov, M. (2018). Capital Structure: Modigliani–Miller Theory. In Modern
Corporate finance, investments, taxation and ratings (pp. 9-27). Springer, Cham.
Liu, S. (2021, March). Competition and valuation: a case study of Tesla Motors. In IOP Conference Series: Earth and
Environmental Science (Vol. 692, No. 2, p. 022103). IOP Publishing.
McCallum, B. T. (1980). The significance of rational expectations theory. Challenge, 22(6), 37-43.
Saito, André & Savoia, Jose & Fama, Rubens. (2013). Financial Theory Evolution. Retrieved from
https://www.researchgate.net/publication/256062706_Financial_Theory_Evolution
Yahoo Finance. (2022). Swvl Holdings Corp. (SWVL)
https://finance.yahoo.com/quote/SWVL/