Introduction to Finance

The previous page in the lecture discussed agency theory to explain the contractual nature of organizations both internally and with boundary organizations. Each of us develops theories to help explain what is happening around us every day. You may have a theory about whether it will rain this afternoon. A personal theory has its place in individual life. For example, a man might have a theory of how a family comes to be either a functional or dysfunctional unit. The man’s family theory was developed over time and influenced by experiences, observations, and interpretations that helped him to choose terms, conditions, and situations that he uses to predict family behavior. In organizations, theory is used also to predict or explain what is happening. In individual and organizational instances, a theory is built upon definitions and systematically interrelated concepts (Cooper & Schindler, 2011).

Relevant Financial and Organizational Theories

Attacking organizational problems, such as those we experience every day in our work world, must be approached in a structured way if we are to reach resolution. The financial manager facing a business problem can never look at all aspects and perspectives of a problem simultaneously. Therefore, the problem and potential resolution must be defined within a framework, or exploration becomes overwhelming. Additionally, a framework helps to reduce bias from those involved in problem resolution. Even when a leader believes that she knows little about the problem, personal preconceived notions still exist. Recall the theory of afternoon rain in the paragraph above. An individual does not consciously think about the afternoon rain theory when clouds begin to form, but undoubtedly a preconception exists.

In the study of finance and financial systems, theory plays a very important role. Financial managers address organizational problems that require a full understanding of theoretical constructs. We don’t think about theory every hour of every day at work, but as we discovered when reviewing the premise of agency theory, financial managers rely on theoretical constructs to understand the organization and make sound decisions. Understanding the interrelated ideas of a theory allows decision makers to critically evaluate whether a particular theory is relevant to a particular problem. When faced with an urgent management problem, a thoughtful financial manager takes necessary steps to better understand options and alternatives to aid in the decision-making process.

In a financial management setting, decision makers rely on asking the right questions to ascertain the right answers. Stating a problem with ambiguity, uncertainty, and misstatement means that the decision maker cannot confidently proceed to find a relevant resolution. An effective financial manager will begin to investigate an organizational issue by first understanding the problem. Often managers describe symptoms of a problem:

· Revenues are down by 5%.

· Stockholders are not satisfied with our financial reports.

· Financial metrics are not consistent across the company.

· Data is not readily available to make sound financial decisions.

These symptoms do not accurately describe the management problem in need of resolution. Symptoms are often interpreted differently by different people. Bias and individual perceptions about symptoms influence decisions. An enlightened manager will often use exploration to take a symptom or ambiguous issue, discover more about the problem itself, and turn the management dilemma into actionable investigation.

For many people, stating an organizational issue in the form of questions helps to frame detailed responses. For example, Sahira has received employee complaints about the lengthy time it takes for her team to create financial reports. Sahira’s team explains that the computers are the problem and that the software programs are too difficult to use and that many hours of manual manipulation of data are required to complete monthly reports.

Spending time to articulate the management problem and research question with exactness and specificity is imperative when conducting sound practical research. Allowing a well-stated management problem to guide decisions on how to solve a problem is a goal of financial managers.