These notes include comprehensive summaries of Chapters 3, 4, 6, 7, 8, 9, 10, 11, 13, 14, 15, 16, 18 and 19 for the Financial Management 352 course at Stellenbosch University. All notes have been made from the lecture slides and the prescribed textbook.
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Chapter 3: Theory building
Introduction
What is a theory?
Theory: A formal, logical explanation of some events that includes prediction of how things relate to
one another. It is a model of reality, a simplification that helps us better understand the logic and
relationships among different factors. A theory can be built through a process of reviewing pervious
findings of similar studies, simple logical deduction, and/or knowledge of applicable theoretical areas.
What are the goals of theory?
The two purposes of theory are:
Understanding: This allows the theorist to gain an understanding of the relationships among
various phenomena.
Predicting: A theory, once understood, enables us to predict the behaviour or characteristics
of one phenomenon from the knowledge of another phenomenon.
These two purposes go hand in hand. In order to predict phenomena, we must have an explanation of
why variables behave as they do.
Research concepts, constructs, propositions, variables and hypotheses
Research concepts and constructs
Research: The systematic investigation into and study of materials and sources in order to establish
facts and reach new conclusions.
Construct/concept: A generalised idea about a class of objects, attributes, occurrences or processes
that has been given a name; an abstraction of reality that is the basic unit for theory development.
Constructs express in words various events or objects. The theory of finance, gross domestic product,
risk aversion and inflation are frequently used constructs. Accounting constructs include assets,
liabilities and depreciation.
Ladder of abstraction: Organisation of concepts in sequence from the most concrete and individual
to the most general. The ladder indicates that it is possible to discuss concepts at various levels of
abstraction. Moving up the ladder of abstraction, the basic concept becomes more general, wider in
scope and less amenable to measurement.
The business researcher operates at two levels: on the abstract level and on the empirical level.
Abstract level: The level of knowledge expressing a concept that exists only as an idea or quality
apart from an object.
Empirical level: The level of knowledge that is verifiable by experience or observation. At the
empirical level, we “experience” reality – we observe, measure or manipulate objects or events.
Latent construct: A construct that is not directly observable or measureable, but can be estimated
through proxy measures. Examples include job performance, customer satisfaction and risk aversion.
While we cannot directly see these latent constructs, we can measure them.
Research propositions and hypotheses
Once constructs are identified, a researcher is interested in the relationship among these constructs.
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