Williams, of Dividend Discount Model Fame, Wanted to Eliminate Market Volatility by Putting Experts in Charge of Setting Prices

The intellectual foundations of modern finance lie in John Burr Williams’s 1937 Harvard dissertation-turned-book, The Theory of Investment Value (Harvard University Press, 1938), and in this ambitious man’s attempt to use scientific thinking to end the wild volatility of markets that had wreaked havoc on the country during the Great Depression.

Williams began his doctoral program at Harvard in 1932 with the goal of discovering the true causes of the crash of 1929. Just as the financial crisis of 2008 formed the first imprint on the minds of those of us who began our careers in finance in the past decade, the stock market crash formed an indelible impression on Williams and the cadre of young scholars who would attempt to invent the theory of finance. He believed that the “wide changes in stock prices during the last eight years, when prices fell as much as 80 or 90 percent from their 1929 peaks only to recover much of their decline later, are a serious indictment of past practice in Investment Analysis.”

Like many in his day, Williams believed in the promise of technocratic governance, that the world’s problems could be solved by men of solid intellect meeting in wood-paneled rooms to weigh in on matters of urgency for society. The dividend discount model, and the application of The Theory of Investment Value, had a simple purpose: making the excess volatility of markets disappear by putting experts in charge of setting prices.

Experts, not traders, would set the prices of the securities in the marketplace. “The time seems to be ripe for the publication of elaborate monographs on the investment value of all the well-known stocks and bonds listed on the exchanges,” he wrote. “The last word on the true worth of any security will never be said by anyone, but men who have devoted their whole lives to a particular industry should be able to make a better appraisal of its securities than the outsider can.”

In addition to making investing a far less exciting practice, Williams believed this new expert-based approach would result in “fairer, steadier prices for the investing public.” These experts needed only his formulas.

Williams’s new science of investing featured the now-familiar dividend discount model. In short, this model quantifies the idea that the investment value of a security is equal to “the present worth of the expected future dividends.”

—Daniel Rasmussen, “The Bankruptcy of Modern Finance Theory,” American Affairs 1, no. 2 (Summer 2017), under “John Burr Williams and the Dividend Discount Model,” americanaffairsjournal.org/2017/05/bankruptcy-modern-finance-theory/ (accessed March 7, 2020).