Financialization and New Economy Boom - Essay Example

To what extent is the pursuit of shareholder value and the ‘new economy’ boom connected to the process of ‘Financialization’? Discuss the implications of institutional investor behavior on corporate strategy and performance? Contents To what extent is the pursuit of shareholder value and the ‘new economy’ boom connected to the process of ‘Financialization’? Discuss the implications of institutional investor behavior on corporate strategy and performance? 1 Contents 2 Context 3 Introduction 3 Relation of Financialization with Shareholder Value and new Economy Boom 4 Financialization 4 Shareholder Value 4 New Economy Boom 5 Relation between Economy boom and Shareholder Value with Financialization 5 Impact of Institutional Investor Behaviour on Corporate Strategy and performance 6 Conclusion 7 Reference 8 Context The economy of the world is changing over the time. This is an era of globalization, when the economy of one country is connected with other economy, which means tan economy has influence on other economy. Financialization is the process through which the influence and the services of the financial institutions increase. It means the importance of the financial institutions is increasing gradually in the economy. The performance of the companies is measured by the financial performance and that attracts the shareholders’ of the companies. The objective of the companies is to increase the wealth of the shareholders. In this changed economy, when the world has just faced the global financial crisis and the debt crisis of some countries is affecting the world economy, the researcher wants to find the relation between the shareholder value and financialization. The institutional investors generally hold a major percentage of shares of a company. Because of this, the opinion of these investors matter a lot for the company management. In this context, the researcher wants to analyze the relation of the shareholders’ value and financialization. Introduction In the era of globalization, when the economy of a country can be affected by some other country’s economy, then the government should make it sure that the base of the economy is robust. For making the economy of a country robust, the performance of the companies of the country should be good. For making the economy strong, the government also should ensure that the financial condition of the fellow compatriots is good enough. When the financial services are available to all the people of the country, then the economic condition of the country will be good. If the product of financial sector increases then the country is there to grow. It means that the country is going towards financialization. It is also a fact that the objective of a company is to maximize the wealth of the shareholders. In the past few years the global economy has also changed, it has seen many difficulties. In this paper, the researcher will discuss the relation between shareholder value and new economy with financialization. The researcher will also discuss the impact of the behaviour of the institutional investor on the strategy and performance of the corporate. Relation of Financialization with Shareholder Value and new Economy Boom Financialization Financialization refers to the way of making profit through the sources of financial channels rather than the production of commodity. The companies have to pay to the creditors of the company at first, when they make profit from the operations. They cannot invest their income for buying some new assets. They have to pay interest to the creditors like the bondholders, the bankers as well as the junk bond holders of the company. Like this, the firms also want to make profit by investing in different organization, by issuing the securities of the firm in the market etc. The cause of the financial crisis of 2007-09 was the housing mortgage crisis of the United States. The United States banks have provided loan to the individuals who were not so creditworthy. The organizations like Freddie Mac and Fannie Mae allowed the lenders to reinvesting their assets and do the credit default swaps (Mckitrick, 2011, pp. 28-30). This is an example of Financialization and the process has failed due to the wrong use of the process. The borrowers have failed to pay back their loans. From the event it was evident that the financialization process can develop an economy as well as the wrong use of it can be harmful for the economy also. Through the financialization process, the company management can get the needed capital for their production and for assuring that the management has to attract the investors. Therefore, they have to maintain a good corporate governance structure in the company and always take care of the stakeholders’ interest. Shareholder Value If a company wants to gain more market share in the concerned industry, then they have to make profit from operations. For making profit, the management should be efficient so that they can use the available resources to them at its best. For gaining more capital for the production, a company needs enough capital. The sources of funds for the companies are the banks, the issued bonds and the issued securities in the stock market. The companies have to make it sure that they get the funds for the production for a long term, so that they have to make an efficient corporate governance structure. The companies have to produce periodical reports so that the creditors become sure about the transparency of the operations of the company. Depending on the financial report, the stakeholders of the companies take the decision about their further association with the companies. For getting, enough funds the companies should provide value to the stakeholders of the company mean the creditors, the debtors, the employees as well as the shareholders. The companies have to give importance to the shareholders, as they are primary source of funds for the company. The company management used to find a position of conflict when they have to identify the objective of the company. Generally, the objective of the company is to maximize the wealth of the shareholders. Pursuing the objective the management also makes it sure, that the company will get the profit in the short run, also it ensures the long-term profit of the company. For ensuring the short-term and long-term profit for the company, the management has to value the opinion of the shareholders and provide them the value added services. New Economy Boom In this era of globalization, when some internal reasons affect an economy, the economies of other countries also affected because all these are related. When the economy of the United States affected due to the bankruptcy of the major banks, the world economy broke down. The stock indices throughout the world have felt. Recently some of the European nations have to face the problem of debt crisis. The problem has started from Greece. After that, other nations like Italy, Portugal had to face the similar problem. The common currency of the Euro zone is Euro. As the Euro has depreciated, all the Euro zone members have to take measures for controlling the situations. The strong economies like Germany, the United Kingdom had to tighten the monetary policy. As the total Euro zone affected and one of the main currencies Euro depreciated, the world economy has to face the problem. These events show that how an economy can affect other economies. Analyzing the two events the researchers has found that the cause of these events is financialization, which was not done in the right process. For sustaining in this globalization era, a country and the companies have to use the process of financialization in an efficient manner. Relation between Economy boom and Shareholder Value with Financialization Financialization means not only the increasing effect of the financial organizations but also the financial services and instruments of the organization, which are from other industries. The financial services company also play a major role in the gross domestic product of the country. If the financial services companies like the banks or the non-banking financial companies are able to provide services to major percentage of people of a country, then the country may become financially stable. The organizations get the capital for their production by issuing the bonds in the market and issue the shares of the company in the stock market. The companies can issue the bonds and thereby they are liable to pay certain interest amount to the bondholders and the principle amount at the maturity. The company get the amount needed by them for the production through the financial instrument. The company can also invest their capital in some other company and they can get the return on investment after some time. This is also a major financial instrument for getting the capital for the funds needed by the company management. One of the major sources for getting the fund for the company expenses is by issuing the securities in the stock market. The company can issue the shares in the stock market and they can get the fund in exchange of that. By using the securities, an organization can get the needed funds from the market. The process of financialization can be successful only when the companies provide importance to the shareholders. For an organization, the shareholders are the persons, who provide capital to the companies against the share issued. For attracting the shareholders, the companies have to respect their opinion, should careful to the needs of them, and provide them value added services (Stockhammer, 2006, pp. 198-213). For a financial services company, the companies have to value the persons who are getting the services. The companies have to know the customers’ need, preference so that they get attracted and take the services. When an organization is providing enough importance to the shareholders then the financialization process become fruitful and the organization can make profit from the services. As the companies are the components of a country, this would also make the economy of a country strong. Impact of Institutional Investor Behaviour on Corporate Strategy and performance Institutional investors are the persons who invest funds in the company on behalf of the third parties. The institutional investors are the mutual funds, pension funds, and the insurance companies. The common people may not have the opportunity to invest in the equities of the companies. The institutional investors accumulate the funds of the third parties and they invest in the equities of the companies. The institutional investors provide return against the investment of the investors. For providing return to the individual investors, the institutional investors want to make sure that they get much return against less risk. As the institutional investors hold a major part of the share of the company, therefore, the company management have to provide importance to their opinion. As the institutional investors generally want to take less risk, so the company management also have to take less risk during their operation. The management has to design the policies and strategies as it attracts the institutional investors, as they are the source of capital, needed for the operation of the company. As per the data, the institutional investors managed $53 Trillion of all the assets of the companies of OECD area. Among this, the amount of equity is $22 Trillion (OECD, 2011, pp. 25-26). This amount signifies the importance of the institutional investors in the OECD area. The institutional investors invest in a large portfolio of companies, so the companies have to promote better governance practices than other companies, which made the practices inside a company better. The institutional investors can influence the important decisions of a company like the compensation of the top executives. From a research, it has revealed that the institutional investors mainly want to provide long-term incentives to the C.E.O. s as well as their opinion get importance as per the shareholding pattern (David, Kochhar and Levitas, 1998, pp.205-207). Conclusion From the previous research papers and the analysis, it has found that the shareholders value and the new economy boom are closely connected with the process of Financialization. A company gets the needed capital for their operation from the shareholders of the company by issuing the shares of the company in the stock market as well as by issuing bonds in the market. These financial instruments are the source of getting the capital from the market. Financialization means to use the financial instruments more and take steps to increase the importance of the financial instruments. In this era of globalization, when there is a new type of global economy, the companies have to use the financialization process in a right process, which in turn help to develop the economy of the country. The institutional investors want to get return on their investment by minimizing risk. Since they used to hold major percentage of share in a company, their opinion is valuable for the company management for getting the needed funds. The company management used to design their corporate governance structure and the strategies by valuing the investors’ opinion, as they are one of the main sources of funds. Reference David, P.,Kochhar, R., and Levitas, E., 1998. The Effect of Institutional Investors on the Level and Mix of CEO Compensation. [Pdf]. Available at: http://auapps.american.edu/~parthiba/amj98.pdf. [Accessed March 21, 2012]. OECD, 2011. The Role of Institutional Investors in Promoting Good Corporate Governance. [Pdf]. Available at: http://www.oecd.org/dataoecd/33/17/49081553.pdf. [Accessed March 21, 2012]. Mckitrick, R., 2011. The US Financial Crisis: Understanding the Causes and Consequences. [Pdf]. Available at: http://www.rossmckitrick.com/uploads/4/8/0/8/4808045/us_financial_crisis.rm.pdf. [Accessed March 21, 2012]. Stockhammer, E., 2006. Shareholder Value Orientation and the Investment- Profit Puzzle. [Pdf]. Available at: http://gesd.free.fr/stockpuz.pdf. [Accessed March 21, 2012]. Read More