Quantum finance
Two beautiful ideas at the turn of the century – general theory of relativity and quantum mechanics – provided those with imagination a reason to live during the bleak times of war and depression. They also fundamentally transformed how we analyze and understand the world around us. For many centuries before that, classical Physics helped advance our understanding of how objects that we can see and feel behave. However, those principles were applicable in a very limited context and these two insights broke the scope of human beings wide open.
Classical finance is in a similar situation. Most of the financial principles applied today by operating companies and financial institutions alike were developed in the 60s. They are useful in the manufacturing of well defined products such as soaps and automobiles. In this modern era, such businesses command a very small percentage of the overall economy. Most of the value created in the economy comes from information and knowledge led innovation. Application of classical finance in these companies is akin to using Newtonian mechanics to understand gravitational lensing or quantum tunneling. They, simply, are not applicable.
Why, then, are the information driven companies in hi-technology, life sciences, energy, aerospace and other such industries, using archaic classical finance to make critical investment decisions? Why are the investment banks that "advise," these firms use such archaic accounting notions such as EPS and accretion to support their recommendations to buy and sell companies? Why are the blue chip consulting firms, who knows almost everything, use massive spread sheets with prescriptive cash flows when they (should) know such forecasts are meaningless? The answer is that none of these players have any incentive to change the status-quo. Leaders of operating companies do not want to deviate from existing financial processes in their complex organizations for fear of doing something wrong. Investment bankers just want to initiate M&A as their fees are critically dependent on such transactions and consulting firms just want to consult with large number of people spending long hours pouring over meaningless numbers.
The maintenance of status quo finance in a world that has changed is destroying significant value. Part of the blame has to go to the business schools who are stuck in education content that is at least 50 years old.
