Truth and Finance

By Mark Leary

Philippians 4:8. “Whatever is true...”: alēthēs. An adjective meaning “true, dependable, real, genuine.”

A recent article published in the academic journal Review of Corporate Finance Studies was titled “Have Instrumental Variables Brought Us Closer to the Truth?” While not exactly click-bait for those outside the field, the title does make one wonder what the search for truth (which Paul refers to as alēthēs in Philippians 4:8) looks like in the academic study of finance and encourages me to think about how that search affects my work as a scholar.  

Finance is an applied sub-field of economics. In my corner of the field, empirical corporate finance, we seek to understand the motives and economic forces that shape corporate financial decisions. For example, when firms raise capital for investment, how do (or should) they choose between issuing debt and equity? What factors influence firms’ dividend policies? What are the most effective corporate governance structures and how do they impact firm value? 

Theory holds that these decisions should minimize the costs created by frictions in financial markets – for example, they should lessen taxes, align incentives, and minimize differences in information between firms and investors. Finding truth in this context means accurately identifying and describing the underlying relation between these economic factors and managers’ decisions. Which factors matter most and which can be safely ignored? What is the true impact of these decisions on the value of the firm?

It may seem at first that a simple collection of data and observation of outcomes would resolve all these questions clearly. But collection, observation, and evaluation are not nearly as simple as we might like. The challenge we face plagues many scholars in the social sciences. Unlike fields in medicine or some natural sciences, we can’t bring a sample of public corporations into a lab, randomly assign different financing choices or change their economic environment, and then see what happens. Rather, we observe data on firms’ actual decisions and their consequences and then judge, as best we can, the motives and economic forces behind them. Our findings are inferences. And inferences face a number of pitfalls. For example, firms with a certain governance structure or dividend policy might have higher market values, but that doesn’t necessarily mean that one caused the other. Another factor could be affecting both simultaneously. Or the data may at first glance suggest a relationship between two variables, but that may only be because we are not measuring them properly or not making a proper comparison. 

In such a situation, what counts as truth? How do we reach “dependable, real, and genuine” conclusions (as Paul’ word alēthēs calls us to)? 

In my work, two related factors become especially important: creativity and integrity. It may seem counterintuitive, but creativity is closely related to the search for truth. Can we find new ways of measuring variables of interest? Can we come up with new tests to mimic real world change? Can we imagine new sources of data that will shed light on the true underlying economic forces driving firm behavior? Discovering “dependable, real, and genuine” results often requires the work of the imagination.

Creativity brings in the second value of integrity, for as we go about creatively searching for solutions, we need to be all the more focused on honest results. Academic papers in corporate finance often marry an economic story with supporting data. We convey truth in narrative form. Researchers must be careful to ensure that the data inform the story, not the other way around.

Why is this a truth worth pursuing? It may seem less noble than pursuing truths about the existence and character of God, or about the identity of Jesus and our identity in Him. Perhaps, but it remains important in at least two fundamental ways. 

First, understanding better the financial world can be part of our vocational calling to cultivate God’s creation and enable human flourishing. The financial industry sometimes gets a negative reputation (often deservedly so!). The misdeeds of bad actors have major consequences, and these types of malfeasance are often highlighted in the media. But the purpose of the financial system is ultimately to enable productive activity. Manufacturers and farmers need capital to produce essential goods. Entrepreneurs with the most creative ideas need capital to research and develop those ideas and turn them into useful products and services. At its best, the financial system channels capital to its most productive uses. Good finance stands behind the making of many good products, good services, and good jobs. It can improve people’s lives, and it's important to do it well. Our research supports that goal when it reaches true and dependable conclusions.

But secondly, and more broadly, getting to the truths in corporate finance research helps us better understand the world that God created. Economics is ultimately a study of human behavior. We study numerical data, but those data represent outcomes influenced by countless human decisions. Making sense of those numbers tells us something about human nature—the objectives and incentives to which we respond. It also tells us about the brokenness of human nature. For example, the design of financial contracts, corporate governance structures, and executive compensation schemes often recognize in their very shape and function that we act in our own interest, even when doing so harms the interest of others. Thinking about how to reach efficient financial outcomes in that context can be one piece of understanding how to live collectively as broken people in a fallen world. 

I am no exception to the general rule. We are each in our own way fallen, and I am sure I fall short of my own ideals in my research, just as I daily fall short of the apostle’s exhortation to focus my mind on what is true, noble, right, pure, lovely and admirable. Paul calls me to what I cannot do on my own. Like the rest of us working in the university, I am left each day dependent on God’s grace to direct both my thoughts and my work toward the discovery of what is true.

Mark Leary is Associate Professor of Finance at Washington University in St. Louis, and a Carver Project Faculty Fellow.