A Discussion Of Banks Controlling Major Equity
In Large Industrial Companies Essay, Research Paper
The inquiry touches to two of import and evidently interconnected issues, that of the demand and signifier of corporate control and that of the function of the fiscal system in resource allotment. During the last two decades the Modigliani & # 8211 ; Miller proposition which stated that there is no relationship between corporate capital construction and the existent public presentation of houses, has been progressively disputed as the importance and power of fiscal establishments is realised. In general, a differentiation is drawn between & # 8220 ; market & # 8221 ; and & # 8220 ; bank & # 8221 ; oriented fiscal systems, which are thought to match to the fiscal agreements of the US and UK on the one manus, and of Germany, Japan and to some extent France on the other. The former are said to trust much more on the equity and stock markets for company finance and corporate control with Bankss holding comparatively small direct links with industry and supplying comparatively small finance. In the Japanese/German & # 8220 ; system & # 8221 ; , on the other manus, Bankss have much closer ties with houses, frequently hold important equity places in these companies, are represented in the board of managers and accordingly supply a greater proportion of company finance. The superior public presentation of the Japanese and German industry to that of the Anglo-Saxon states is frequently thought to bespeak that the former have a & # 8220 ; superior & # 8221 ; fiscal system. We should bear in head, nevertheless, that the differentiations are non ever as clear. Japan, has besides a big stock market and the equity retentions of fiscal establishments are high in Britain excessively, although the equity retentions of establishments in UK are concentrated in pension financess and life insurance houses instead than Bankss, though the exact significance of that is non clear. Besides, we must be cognizant of the of all time present informations jobs, particularly when doing international comparings. A recent survey has found that, in fact, bank loans form a greater proportion of investing finance for British houses than German houses. Another point that has to be made is that the seemingly & # 8220 ; superior & # 8221 ; public presentation of the & # 8220 ; bank-based & # 8221 ; economic systems need non be an result of the fiscal system as evidently many more factors are at work here. Even more significantly the causing may run the other manner unit of ammunition since high growing would likely necessitate high investing rates and therefore high pitching ratios. Mayer, nevertheless, replied that the electronics industry in the UK and US which besides experienced rather high growing and high investing, in fact, has an even lower proportion of external finance. Nevertheless, the position that Bankss are willing to impart more if merely the houses asked them to, is rather popular and it implicitly puts the incrimination for the unimpressive British public presentation on the directors and corporations. Other findings that stock market financed investing is more profitable to debt financed one, with internally financed undertakings being the less profitable of all, could be interpreted to connote that it is so the directors & # 8217 ; instead than the fiscal sector & # 8217 ; s mistake, who prefer internal capital so as to avoid control and be slack ; instead it could be interpreted that the fiscal sector is uninterested in industry, except in instances where the returns are truly exceeding. The essay inquiry asks about Bankss having equity in industrial corporations but this does non look to be a important characteristic in the interactions of the fiscal system with corporate public presentation. The differentiation between equity retentions and bank loans is progressively blurred given the procedure of securisation in the last 2 decennaries. The two elements which are likely the most of import are first, the extent of supervising Bankss do over the houses they have dealingss with, i.e. whether they follow a & # 8220 ; hands-on & # 8221 ; attack or are inactive to direction determinations, and 2nd, whether the Bankss & # 8220 ; lock in & # 8221 ; specific houses. Both these characteristics have of import -and controversial- deductions for both the efficiency of recognition allotment and the grade of corporate control. Banks keeping equity bets is merely of import to the extent that it affects these two characteristics of Bankss & # 8217 ; and houses & # 8217 ; behavior and as we will see subsequently on it is likely non really of import. Equally far as resource allotment is concerned, the ability to & # 8220 ; lock in & # 8221 ; a company, peculiarly when it is still little and new, allows the bank to take a more long-run position and leads to better hazard allotment. Most new houses, or new undertakings, tend to incur losingss for, say, the first five old ages until they manage to get down gaining net incomes so that many of them do non last that long. Therefore, Bankss would be really hesitating in imparting them since the fright of default would be really high ; bear downing really high involvement rates to countervail this hazard is likely to decline even further the opportunities of endurance of these houses and possibly pull & # 8220 ; unwise & # 8221 ; enterprisers. Rationing of recognition is, therefore, widespread and new houses and undertakings are frequently prevented from taking topographic point. If, nevertheless, the Bankss locks itself to the house and the house to the bank, so the bank may be willing to accept lower involvement payments while the house is still immature and delicate in exchange to more advantageous footings and higher net incomes in the long-run. If the 2 parties had non committed to each other, so the house could, one time it became large and respectable financially, abandon the bank which had helped it turn and pull financess more stingily from the market. This is a powerful statement, though it has to be established that this is what happens in Germany and Japan, particularly every bit far as little houses are concerned. The celebrated Nipponese bank-industry links, for illustration, are chiefly between large companies and large Bankss instead than little advanced and bad houses. The statement loses much of its significance when it is valid merely to comparatively large houses since these houses are less forced for finance. Still, when a bank is locked in a house, it is by and large more likely to back up it in times of problem. Indeed the attitude of Nipponese and German houses towards houses in danger of default is supposed to be much more supportive, though once more the extent of the different behavior of these states with the UK and the US is controversial. A possible job with lockup in is that it has a inclination towards monopolistic state of affairss both in the fiscal and the industrial sectors. When a house is locked in with a bank, this means that it
will not be available to search the market to find the cheapest source of finance. This lack of competition is likely to increase costs and inefficiency within the banking sector. Oligopolistic influences may be exercised over the industrial sector as well, since when banks are “locked” in one (or more) firms in an industry, they would be unwilling to fund new entrants. Other problems include that as the banks take some of the risks from the companies, we may have over-insurance resulting in managerial slack or overly risky behaviour. Furthermore, the arrangements which are likely to result from such intimate relationships between firms and banks are likely to be excessively secretive -as is often the case in Germany- leading to unaccountability and perhaps corruption as in Japan. The extent of involvement of the banks on the management of firms -which is clearly related to the extent of “locking in” – is also likely to influence credit and resource allocation. One may argue that the more information the banks have about the firm, the more likely they are to make the “correct” decisions on which projects and firms o finance and on what terms. On the other hand, it is argued that it would be better is this knowledge were widely available since many agents are more likely to end up with a better outcome. The conclusion to such a debate would be largely dependent on our opinion about the Efficient Markets Hypothesis, in other words the ability of a decentralised, competitive system to allocate funds and determine asset prices, through the stock and bond markets. However, the proportion of funds drawn from the stock market is surprisingly low so, indicating that perhaps its “excessive” volatility and, perhaps its short-termism does not make it a popular medium of finance for most firms. It is perhaps strange to notice, however, that often much of the volatility and “irrationality” of these markets is in fact attributed to these financial institutions which are here claimed to provide a more long-term and sober approach to industrial funding. The second issue we have to examine is that of corporate control. This issue has arised because of the separation of ownership from control as share ownership has been dispersed and hence the control of owners over their company is diminished. The significance of this separation is highly controversial with some arguing that this has altered the whole nature of capitalism as managers are socially conscious and less concerned with profit maximisation, while others point out that there has been little evidence of a slackening of the profit motive. In any case, most recognise that managers -and by extension all firm employees- are likely to have other objectives to solely profit maximisation – the most frequently proposed are sales maximisation and slackening of work effort. Therefore, a high degree of bank involvement and control over corporations is often thought to prevent the “managerial thesis” from being realised. Once again, there is considerable debate regarding the extent and effectiveness of financial control in the non-anglosaxon economies. Indeed a number of corporate troubles in Germany has indicated that financial control may well be overrated. There are many possible ways for financial institutions to exercise control or influence over firms. One possible way is to own stocks and exercise its influence through shareholders’ voting. This is unlikely to be very effective, though as rarely questions of great strategical importance are put to the vote while in most cases banks do not own a controlling proportion of shares. It has also been proposed that banks exercise influence by threatening to sell their shares but this is unlikely to be of major importance as the banks would also lose if they sold their shares quickly. Representation on the board of the company is another possible way but again in most cases, these boards are largely ceremonial and the bankers themselves often seem not to give them much attention. Thus the most common way for banks to exert influence is in indirectly consulting the managers, based on the power that they have from providing a large part of the firm’s finance, irrespective of whether that is in the form of shares or bank loans. It should be noted here that the importance of and the need for such financial control is significant only when the market fails to do that by itself. Those who again believe in the EMH, would see takeovers as an effective way of keeping the managers in check. There are numerous problems with takeovers, however, due to imperfect and asymmetric information and short-termism . Another question that arises is that if such close relations between firms and banks are thus mutually beneficial, why don’t all banks in all countries do the same. We also have to examine whether the interests of the financial institutions are identical with those of the shareholders of the non-financial firms. In a sense their interests differ since the owners of the firms want to maximise profits while banks want to maintain solvency. In the long run, however, the best way to guarantee solvency is to maximise profits so, though banks may be more cautious than perhaps required for short-run profit maximisation, there will probably be no important conflict of interest in the long-run. Nevertheless, problems may arise when banks control more than one firm in an industry in which case it may encourage collusion (which is probably in the firms’ interests, though it may not be in society’s interests) or at worst run down one of the firms or encourage its takeover/merger to reduce competition. Again, the problems of accountability and secrecy are relevant here. I would like to conclude with the “optimistic” view that, to a large extent, the two types of financial systems are not completely mutually exclusive so that it could be possible to combine some of their best features. I can see no particular reason why competitive and dynamic financial markets are incompatible with a banking structure which is more responsive and closer to industry. Already there are signs that, for example, the pension funds in US and to some extent the UK have abandoned their “obsession” with short-term performance and are switching to index linked portfolios which could be a basis for both a more stable and efficient stock market and, hopefully, greater relations between firms and financial institutions.
