Financial Theory is a branch of economics that studies the effect of various economic policies on the value of assets or income. This branch of economics looks into the measurement of value of various assets or income categories using various techniques like the theory of demand. In particular, financial theory applies three important tenets to help individuals calculate the value of their assets or income. The following discussion highlights the relevance of financial theory to the current debate on the world stage.
The primary aim of this paper is to illustrate that firm investments are sensitive to misvaluation. Drawing insights from firm-specific analysis, the research reveals that financial leveraging is significantly and negatively related to firm valuation. Moreover, it is seen that the negative effect of leveraged firm investments on firm valuation is quite significant for high information asymmetrical firms. By implication, it is suggested that firms with higher capital shares should be expected to experience greater deviations from fair value and more potential for financial misvaluations.
The second step of the logic diagram is derived by considering the existence of informational asymmetries. According to the third step of the logic diagram, if there exists a great deal of variation across firms regarding aspects like credit quality, sector liquidity, portfolio structure, etc., then an investor who wants to take risk in such a scenario will more likely suffer from financial misvaluations. Taking cue from the financial theory that states that information can cause price changes, the fourth step of the logic diagram identifies that information can also cause misvaluations. By implication, it is concluded that market participants have a keen interest in assessing the effects of leveraged firm investments on firm valuations and as such, they will try to exploit any information asymmetry.
The fifth step furthers the logic diagram study by arguing that high capitalization firms have fewer opportunities to experience financial misvaluations due to the exorbitant costs of such investment strategies. Finally, analysis shows that when a firm invests in a large-scale asset like a plant, it not only increases the overall value of the firm, but also boosts overall profits. Analysis further shows that this advantage provided by large-scale investment strategies can offset the disadvantages inherent in other firm investment strategies. Given this logic, it is concluded that if firm managers were to adopt certain investment techniques, they would not face the risks associated with leveraged investments. In short, it is suggested that high-end managers can extract great benefits from existing firm investments by properly exploiting financial opportunity.
Leveraged investment strategies have been a staple practice of corporate finance and the present-day corporate environment. These investment strategies have successfully offset the declining returns of traditional venture capital. However, the recent case studies point out that while leveraged investment strategies have been a boon to the major investment banking institutions, they have been a problem for small banks and other small-scale financial institutions. On the other hand, the present-day management challenges the view that the present scenario favours concentrated ownership of assets and hence investment in financial instruments like firm bonds and mutual funds are the answer.
Financial market surveys point out that firms today are increasingly focusing on firm balance sheets, including firm asset valuation and firm balance sheet optimization. This focus is reflected in the fact that firms have started outsourcing some of their financial activities such as cash management, loan disbursement, and purchase of assets to external agencies such as law offices and venture capitalists. As a result, some of the tasks that used to be performed by the finance managers have now been outsourced to financial advisory firms, as firms have realized that these firms have the expertise, and the time to ensure that a proper financial analysis has been carried out. To conclude, it is clear that while investment in financial instruments is advantageous, prudent management should still be adopted for improved financial results. Accordingly, effective financial management practices, such as proper investment objectives, monitoring of investment activities, and prompt repayment of excess cash are key factors to a sound venture capital investment strategy.