Role of Financialization in the Financial Crisis - Assignment Example

?To what extent is the banking crisis, the pursuit of shareholder value and the ‘new economy’ boom connected to the process of Financialization. Discuss the implications of investor behaviour on corporate strategy and performance? 1. Introduction The severe turbulences that followed the financial crisis of 2007-2010 have raised concerns regarding the level at which the global financial system is ready to face critical failures. Moreover, the question whether the financialization process, which has been promoted worldwide more than a decade, has been related to the above crisis has not been avoided. In fact, there are many indications that the specific process had a major role of the financial crisis of 2007-2010. Its potential involvement in a new crisis of such kind cannot be rejected. Current paper examines the role of financialization process in the banking crisis of 2007-2010. Moreover, the potential relationship of the pursuit of shareholder value and the ‘new economy boom’ with the process of financialization is also explored. The examination of the literature published on the specific field has led to the assumption that the relationship between the above-mentioned events and frameworks is strong. At the next level, another issue is also discussed: the level at which investor behaviour can influence the corporate strategy and performance. It is proved that the involvement of shareholder value in corporate strategy and performance can be significant influencing the corporate decisions on critical issues, as for example the strategies that the firm will follow for facing the expansion of financialization, as a global economic trend. 2. Financialization – role in the financial crisis of 2007-2010 2.1 Financialization – overview Financialization, as a sociological and economic trend is not a recent phenomenon. In fact, in accordance with Orhangazi (2008) three phases can be identified in the development of financialization: the first one represents the pre-1980 period during which financialization was based on a ‘long waves approach’ (Arrighi 1994 in Orhangazi 2008, p.41). In the years that followed 1980, the financialization was related to the concept of neoliberalism (Orhangazi 2008). Recently, financialization has been related to the global financial markets (Orhangazi 2008). The view of Lucarelli (2011) that “financialization is related to the capitalism’ (Lucarelli, 2011, p.111) seems to be the most effective description of financialization, as a trend influencing the performance of the global financial system. On the other hand, Krippner (2011) refers to financialization as the ‘growing importance of financial activities as a source of profits in the economy’ (Krippner 2011, p.27). 2.2 The relationship between financialization, the banking crisis, the pursuit of shareholder value and the ‘new economy’ boom. As noted above, the financialization focused on the use of financial activities as the main source of profit. At the next level, financialization is an economic trend accepted and promoted globally, which means that it can affect the global financial system. The role of the financialization in the structure and the development of financial transactions worldwide has been revealed through the banking crisis of 2007-2010 (Foster, 2007). It was because of that crisis that the role of financialization for financial systems internationally has been set under consideration (United Nations, 2009). Financialization should be considered as a key cause of the appearance and the expansion of the 2007-2010 crisis, because of the following reasons: a) in the context of financialization the accumulation of profit worldwide has been related to financial activities; the exchange of money in its various forms has become a key method for achieving profit. In this way, the traditional method for gaining money, the work as a physical activity has lost its value. Moreover, new types of work have appeared: communication and negotiations for achieving a good deal in the exchange of financial products has become a quite profitable job. In other words, financialization has introduced radical changes to the role and the form of work (Lucarelli, 2011). Such transformation could not last for quite long, especially if taking into consideration the fact that the main sources of economies worldwide refer to the land (agriculture, stock farming, natural/ energy resources) or the water (fishing, management of water for irrigation). The development of other forms of work, as a result of the changes in the workplace and the increase of the population in the cities, could not last for long not being adequately supported (for instance control on the level of wages/ benefits of employees ensuring the equality and fairness in remuneration); b) it was in the context of financialization that the introduction of financial products of high risk has been decided. These products could offer the benefit of a high profit also, but their pay back could not be guaranteed. In this context, the international financial system was based on the expected profits of financial products, the performance of which was not guaranteed. The over-estimation of the potentials of financial products, in the context of financialization, has led to the banking crisis of 2007-2010. Moreover, because of the increased trust to the international financial system – which was based on the rules of financialization – there were no effective measures for facing a potential crisis. In this way, the financialization should be considered as responsible not just for the appearance but also for the expansion of the financial crisis. Apart from financialization, the global banking crisis has been related to other factors and events. The pursuit for continuous increase of the shareholder value has led executives in risky investment decisions. The pressures by the investors for continuous increase of the organizational profits as followed by the increase of the shareholder value, has caused the increase of corruption in the management of corporate wealth. In the literature, the relationship between the financialization and the shareholder value is so close so that the term financialization is often used instead of the term ‘shareholder value’ (Krippner 2011, p.27). The ‘new economy boom’ is expected to face similar problems, either in the short or the long term, if appropriate measures are not taken for the limitation of financialization, or else, for the limitation of shareholder value as a criterion for developing corporate strategies. 3. Implications of investor behaviour on corporate strategy and performance Investors can have a critical role in the development of corporate strategies. In fact, they are the investors that decide on all the critical issues that a corporation has to face. The increased power of investors within modern corporations has been explained using the following arguments: a) investors have key interests on their corporation; their participation in the key corporate decisions should be regarded as quite satisfied since they are their interests that are in risk. However, this view could be opposed as follows: investors are not the only individuals who have interests on a particular corporation; employees, customers, suppliers and even the state have interests on the relevant corporation (in the context of their role as stakeholders). For this reason, all the above persons should also have access – along with the investors – to the meetings involved in key strategic decisions (Morgan et al. 2010), b) through another point of view, corporation, as any other organization, needs to be governed in accordance with a specific strategy; the application of the corporate mission and aims – as included in the corporate mission statement – needs to be closely monitored on a continuous basis. Investors should have the role of the control of the corporation ensuring that all key strategic targets are effectively pursued (Orhangazi, 2008). It is in this context that key corporate decisions are set for verification by the meeting of shareholders, a term commonly included in the memorandum of association. Despite the above issues, it could be noted that the involvement of investors in corporate strategy can have important implications. At a first level, investors are individuals and can be influenced by their personal perceptions. This means that when being asked to participate in the development of a critical corporate decision, investors are expected to express their view, as being aligned with their perceptions on the issues under discussion. However, this fact, can lead to severe organizational turbulences, especially in cases where there is a conflict between the interests of the shareholder and the interests of the organization, as for example the case in which the investors are asked to vote on the reduction or even the elimination of dividend for a particular period of time. Furthermore, investors are expected to have different educational and cultural background; they may develop different estimations regarding an important corporate issue. In this context, the explanations given to the investors regarding a particular corporate problem will be interpreted differently by each of them. The result would be the conflict among the shareholders regarding the direction that the corporation should follow on the issue under discussion. In this context, severe delays could be caused regarding the development of an important corporate plan. From this point of view, the involvement of investors in the design of corporate strategies can negatively influence the corporate performance. The above problem could result because of the following fact: in cases of emergent organizational problems, the direct response of investors is quite difficult. In such cases, the delay can lead to severe organizational damages. It is necessary that a mechanism exist in place so that an immediate response exists in any case of emergency across the organization. The lack of such mechanism and the provision that the involvement of investors in such decisions is obligatory could result to the expansion of damages across the organization, a fact that could severely affect the organizational performance, either in the short or the long term. Another implication of the investors behaviour for the organizational performance could be the following one: investors have access to key organizational information; their obligation for keeping these pieces of information safe is of key importance for the success of organizational plans. Under certain terms, the success of an important corporation plan may be set in risk if the details of this plan are discussed with all the corporation’s investors. It is not implied that the investors are expected, necessarily, to publish the relevant information; however, the risk, ever minor, for such outcome is significant, having in mind that important details may be published to third persons by accident, i.e. the existence or not of intention would not change the effects of such event. It is in this context that the exclusion of investors from certain corporate decisions would be imposed, setting the interests of the corporation as a priority. 4. Conclusion Through the issues discussed above it has been made clear that financialization has a key role in the form and the performance of the global financial system. In fact, the specific system has been designed and developed using the rules of financialization, as discussed above. Therefore, the specific concept could be held liable for any failure of the international financial system. The examination of the literature published in the particular field verified the above view. In fact, it was proved that financialization had a critical role in the appearance and the development of the banking crisis of 2007-2010. At this point, the following issue appears: at what level the international financial system, in its current form, is secured towards financialization? Also, under what terms other frameworks and concepts, like the shareholder value and the investment behaviour can interact with financialization? In accordance with the views of theorists who studied the specific subject, the banking crisis of 2007-2010 did not appear solely because of the financialization. There were other factors and events, like the pursuit for shareholder value and the investor behaviour that created, in the context of financialization, the necessary conditions for the appearance and the expansion of the crisis. In accordance with the above, financialization, along with investment behaviour and the pursuit for shareholder value, led to the development of the extreme crisis of 2007-2010. The above crisis revealed another important problem: the strong dependency of corporate strategy on the investment behaviour and interests can have severe consequences both for the local and the international market. The current challenge would be the identification of the measures that would prohibit the appearance of similar phenomena in the future. The control on financialization and the limitation of the involvement of investors on strategic corporate decisions would be a first initiative towards the achievement of the above target. References Foster, J. (2007) The Financialization of Capitalism. Monthly Review, Vol. 58, Number 11 [online] Available from Krippner, G. (2011) Capitalizing on Crisis: The Political Origins of the Rise of Finance. Harvard University Press Lucarelli, B. (2011) The Economics of Financial Turbulence: Alternative Theories of Money and Finance. Cheltenham: Edward Elgar Publishing, 2011 Morgan, G., Campbell, J., Crouch, C. (2010) The Oxford handbook of comparative institutional analysis. Oxford: Oxford University Press Orhangazi, O. (2008) Financialization and the US economy. Cheltenham: Edward Elgar Publishing United Nations (2009) Trade and development report, 2009: responding to the global crisis: climate change mitigation and development. United Nations Publications Read More