Simple and Intuitive Business Practices in Financial Economics

Abstract

In stark contrast to the sophisticated methods advocated by academics in business schools, actual business practices are typically simple and intuitive (e.g., valuation, debt management, compensation). Methods that have these characteristics are more likely to become widely used business practices for two reasons. First, they are less prone to overfitting to a particular setting and therefore are robust across economic environments and applicable in new settings. Second, they are easy to communicate and are verifiable. Therefore, they can spread easily across organizations and are hard to replace with new and improved methods. This explanation of business practices can help resolve puzzles in corporate finance, such as the variation in debt leverage across industries.