The “Bright Star” of B-School Research: Finance

While other academic fields lie almost fallow — drawing criticism for lack of relevance — examples abound of finance research that makes a difference.

Our Tuesday article, “Business School for Dummies?” looked at the drive at accrediting group ACCSB to move research in the direction of providing more useful lessons for the business world.

Even as business schools draw fire for producing too little research of real relevance to Corporate America, the area of finance may be the single most notable exception — an area in which theory after theory is used to solve daily business problems.

“Finance is the bright star,” says professor Gabriel Hawawini, one member of the AACSB “Impact of Research” task force, which strongly suggested in its recent report pressing for academic studies to do more to fill the needs presented by American business. “If you ask what contributions have been made, you would put finance at the top of the list for models, principles, and theories that are in use today,” adds the Hawawini, currently a visiting professor of finance at the University of Pennsylvania’s Wharton School.

He declines to join the crowd of critics who say business schools have failed miserably in practical research in non-finance areas — critics who emerged in force when the AACSB’s task force published its draft report last August. Rather, the problem to Hawawini is a matter of balance between pure research and pragmatic study. And the overbalance toward less-relevant research in the United States comes from “how academics come across the problems they study, when they decide to tackle a subject.” If researchers are reading only the academic work of others, and that work is aimed only at academics and not business people, a certain amount of inbreeding can result, he suggests.

“That’s why it’s important to create bridges between the academic world and the business world,” he says. “Academic and practicing business do overlap.”

The Bridges of Chicago

In finance, the existing bridges often have the look of eight-lane thoroughfares.

The AACSB task force noted the work on stock-option backdating done in recent years by professors at the University of Iowa and New York University, which lay the groundwork for policy changes — and perhaps even prosecutions of managers who abused the system by picking artificially low strike prices that gave executives “in the money” compensation that wasn’t properly recorded and taxed. Hawawini ticks off numerous other finance-related contributions made by academia: from portfolio-analysis, risk-pricing, and efficient-markets theory, to the capital asset pricing model and the Black-Scholes stock-option pricing system.

Much of the finance research “has revolutionized the science of mutual funds,” he notes. “It’s made major contributions. In fact, over the last 40 to 50 years, the whole revolution in finance has come, I would argue, from two major drivers: academic contributions, and the computer and IT.”

Of course, those two drivers are often intertwined these days. “The computer has allowed for the rapid analysis we now see,” according to the professor, noting the benefits of data analysis involved with the stock-option backdating research. “That’s part of the revolution, as researchers fish around and dig into the data. And we’re going to see more of that.”

Perhaps the brightest research glow, in his view, “is the whole field of finance that started with the Chicago School in the Sixties and Seventies” — home to Nobel Prize-winners like Myron Scholes; Robert Fogel (for using economic tools to understand historical institutions and trends); Gary Becker (extending microeconomic analysis to human behavior); Merton Miller (applying microeconomics to corporate finance); and Ronald Coase (showing how property rights and transaction costs shape economic activity).

Many fans of more-pragmatic business-school research see the University of Chicago as a model for others, both in its applied studies and in the way it combines strong executive education with the rigor of pure academic work. (Still, finance theory — from Chicago and elsewhere — comes in for its share of criticism. Recently, some writers have been suggesting that severe weaknesses in the Black-Scholes model, for example, exacerbate downturns, rather than cushioning them.)

Heading in the Right Direction

Hawawini notes that in addition to being a rare finance voice on the AACSB task force, he was also the panel’s sole European. (A native Lebanese, he now holds a chair in finance at INSEAD in Fountainbleau, France.) And from that perspective, he sees major differences in the corporate-academic relationships that exist in Europe, compared to the approach in the United States. “The MBA came late in Europe, so more executives did not go to business school,” he observes. The relationship between business-school professors and corporate finance directors and other executives is closer there. “Thus, you have a number of reasons why executive education is more central to a business school in Europe.” And because executive training provides a healthier part of a school’s income — roughly half at INSEAD and some others — that helps make research serve practice more directly, as well.

Meanwhile, “U.S. schools rely more on funding from alumni. That’s why younger U.S. business schools, for historical reasons, don’t have this level of funding.”

But the professor believes that — even before the AACSB recommendations begin to take hold — American business education may have started heading in the right direction on its own. “Fewer researchers are addressing purely conceptual issues these days,” he says. “It’s not just in finance, but elsewhere, like marketing and behavior.”

Adds Hawawini, “You could argue that the [AACSB] report is really catching a trend.”

In finance, research has continued along practical lines in numerous areas, not just at Chicago, but at school after school. “I think the whole issue of transparency, and how transparency and asymmetric information affects trading, will become increasingly important,” he says, for example. “And market efficiency; now that we recognize that, yes, markets are efficient, the paradox is that you must continue to make money. You’re going to have to have some private information.”

The professor agrees that Wharton has emerged as another model school, like Chicago, for the way it combines its executive education and research, and for its development of more popular channels like “Knowledge at Wharton.”

“That’s the direction more schools should be going in,” he says. “They need to integrate their executive education into the heart of their business education offering.” And continue to encourage “the younger professors to get close to the business people early on in their careers. They’re the ones that do most of the research.”

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