Financial or Economic Systems - Essay Example

FINANCIAL OR ECONOMIC SYSTEMS Introduction Corporate governance continues to be the motto of the business sector for both developed and transitory economies. The collapses of 2008 resulting from the financial crisis were critical in pushing the button for corporates to alter corporate actions and restructure to access a wider market. It also alarmed governments to initiate radical reforms of existing corporate governance to salvage the situation. Transitory states awoke to the realisation that the privilege of investors inclined to companies and economies that implement sound corporate governance. In relation to this, the challenge of the industry is double-edged: the harmonisation of corporate governance to universal standards and the improvement of competitiveness to enhance the attraction of more investment. Economic systems and corporate governance A great diversity exists in both the status of corporate economic systems and the measures to enhance them in most countries. Presumably, the stated diversity is a reflection of the variegated circumstances of every country (Jones and Kirby, 1991). The circumstances include the development state of a nation, the relation between government and business, the financial structure inclusive of funds procurement structures, the shareholding structure and the market for talent among others. Of interest are the commonalities that surface in the direction of system improvements. To say, the direction of enhancement in governance via mutual supervision and the improvements in mechanisms to this end is a typical feature in most countries with most countries endeavouring to enhance corporate systems (Hall and Soskice, 2001). All this aim at maximising long-term corporate value based on the perspective of an array of stakeholders (Lane, 1989). Nevertheless, it is worth noting that the approaches to enhancing corporate governance differs in relation to a country's economic ideology as earlier mentioned. For instance, a capitalistic economy would approach governance from a different viewpoint compared to a command-based economy. From theory, it is widely known that command economies dictate that the government makes the decision on the goods and service to be produced, coupled with their distribution (Johnson, 1983). In this economy, government officials evaluate the needs and resources of the country or state and allocate or distribute the resources according to the evaluation. Arguably, rather than hedge on the requirements of individual consumers, service and goods delivery inclines to aggregate needs. The state also wholly owns all the means of production, that is, factories and the resources (Boyer & Drache, 1996). In contrast, the free market presents a different approach relative to the command economy. The free market economy entails individual's choice, and not the state's directives. In this system, producers and consumers drive the economy. The government institutes no bottlenecks to the consumption and expenditure levels of its citizenry (Foreman-Peck & Federico, 1999). The mixed economy is a blend of both economic systems. Such that, the mixed economic system, features both the characteristics of socialism and capitalism (Crouch, 1997). The system allows some levels of private economic freedom towards the utilization of capital. On another hand, the governments are prohibited from interfering in economic activities in order to achieve social aims (Ashworth, 1991) The dynamics in the global business environment have been critical to the transitions of most former socialist states. As the competition for market continued to stiffen, the push for more liberalisation in the markets has seen former controlled economies depart from the hard-line stands of control. A myriad of structural transformations continues to characterise the transitioning economies as they aim for more market-based institutions. These are inclusive of economic liberalization, especially where prices are under the commands of the market forces rather instead of centralized planning organization (Hasan & Turan, 2013). Furthermore, there are several trade barriers that are removed or dealt away with, especially where there need for privatizing the state-owned resources and enterprises. The said process has or is been applied in China, and some Third world countries (Stopford and Strange, 1991). The transition economy process is characterized by the changing or creation of institutions, especially the private enterprises; alteration of the government’s role, and hence thereby, creation and the promotions of privately owned enterprises and markets (Radtke and Wiesbron, 2002). Financial System In the recent years, the issue of corporate governance has become the focal point for most literature. The classification of the financial systems hedges on the basis of the relative importance of banks and markets in corporate financing. The differentiation stems from the fundamental dichotomy between two general forms of financing- the arm’s length and the control-oriented finance. Bank-based systems The financial systems dominated by control-orientated finance promotes a higher level of concentrated ownership structures and much less of liquid financial markets (Miyajima, et al, 1998). The relation between financiers and enterprises is mostly long-term and inclines to ongoing exchanges of information. Repeated and established relations are vital to the reduction of informational asymmetries and agency expenditures. For stylised credit-based systems, long-term bank loans and long-term ownership titles by banks are the dominant types of investment finance. Most monitoring are integrated in a single institution that involves itself in three monitoring stages. The stages include the selection of clients and investment strategies, the monitoring of the projects on a continuous basis coupled with interventions when poor performance checks. The German house bank and the Japanese main bank system mark as the most prominent examples of the bank-based systems. Japan-Germany case A distinguishing feature of the German and Japanese post-war, political economies is the bank-based financial system. Typically, they were characteristic of having a larger portion of bank deposits and loans in entire domestic financial assets and liabilities. During the post-war era, banked based systems were superior since they could offer long-term patient capital to industry with policy makers perceiving them as antidotes to industrial demise. Nevertheless, starting from the 1990 onwards, the system faced a series of challenges. Firstly, an overall structural trend since the 1970s, the shift of domestic clients in the form of nonfinancial firms and the government to state-based source of financing accelerating in the 1990s (Mowery and Nelson, 1999). Moreover, macroeconomic developments inclusive of global growth and policy-induced demand shocks created bad debt problems. Post-war Japan and Germany shed may elements in relation to the societal foundations of bank-based systems. They both exhibit an industrial structure with a bias to manufacturing and a large concentration of SMEs. Arguably, the societal foundations of bank-based systems in either nation continued to face similar pressures. Financing patterns for large corporates in both economies saw a shift in the 1970's a result of stagnated growth. Scholarships provide that the demand for external finance experienced a decline (Medalla, 2005). As such, larger companies that succeeded in reducing their debts level became principal proponents of the market-based finance. It is thus explicit that the greatest shift in preference towards market-based finance in both nations occurred amongst large firms and the state. The German economy is characterised by competition of local firms, and high level of consensus among interested groups; for example the major banks, labour unions, and industry. The post-World War II government got control of the banking, finance industry, and embarked on further strict macroeconomic policies (Berend, 2006). The state legislation on the corporate governance and industrial relations has been significant with a firm establishment of ‘social markets'. The firm markets integrate with market mechanisms, for example, the support of inter-firm and sophisticated banking, and the welfare systems (Tsai and Pekkanen, 2005). Market-based systems Theory asserts that arm’s length finance bolsters ownership of debt and equity and as such, liquid markets for financial instruments. Armed with thick and liquid markets, the investors are portfolio-oriented making the relationship between financiers and firms short-term oriented and akin to spot transactions (Coates, 1996). The system has seen the exit of the primary mechanisms of influence and corporate control. For stylised representations of the market-based system, the issuance of bonds, equities and retained profits dominate investment finance. Further, bank loans majorly serve as short-term smoothing factors (Ohmae, 1996). Within the system, a significant amount of liquid and thick financial markets offers an array of financial instruments. According to Reich, (1990), specialised institutions such as commercial banks, investment institutions, and venture capitalists serve in the capacity of monitoring agencies. The United States and United Kingdom is a prominent example of market-oriented systems. The US-UK case The United States utilizes the non-intervention philosophy from the federal state towards the private economic sector. The state ensured competition through the macro-fiscal or monetary policies in its post-World War two policies on trade; the U.S. urged liberalization in its market, and reduced tariffs in the multilateral engagements. The U.S. has finally embraced unilateralist tendencies, for example, the trade disputes with the EU and Japan for unfair competition. The UK through its state agencies, for instance, the Department of Trade and Industry began the macroeconomic management program in the 1960s and 1970s (Sylla andTilly, 1999). As from the 1980s, there were pursuits of policies of deregulation and privatisation; hence, nowadays the UK is in the intermediate position of a social market capitalism and pure market capitalism (Randlesome, 1990). Anglo-American System The Anglo-American model lays emphasis on the interests of shareholders. Typically, it supports a single-tiered board of directors that is mostly dominated by non-executive directors elected by shareholders. In the system, most boards include some executives from the firm. The Anglo-American system of which organizations depend more on the internal sources of funds, thus independent from principle or major banks. The source was responsible for more than 3/4 of finances towards invest in the U.S. and UK as from 1970 to 1985 as compared to less than 71% in Germany and Japan (Johnson, 1982). Convergence to the Anglo-American system A developing array of literature is comparing different models of capitalism from alternative analytical frameworks that highlight the nature and extent of diverse forms of capitalism. Typically, the forms of capitalism in existence adopt a firm centred approach that focus on the incentives of coordination. The wider typology of governance mechanism in terms of social forms of production coupled with the national business systems approach that analyse the capacities of most businesses. The different in existence has a wider resonance in the consideration of comparative corporate governance. For long, an intense debate has ensued regarding the globalisation and convergence of corporate governance. Of question is whether economies will converge on a common corporate Anglo-American governance system. Stagnated economic growth coupled with high levels of unemployment in Europe relative to the Anglo-American nations starting from the mid-1990's significantly undermined the confidence in Europe's social model (Chandler, 1998). In spite of the pressures towards the adoption of the Anglo-Saxon models of corporate governance, divergences in either policy and practise of corporate governance in Europe has so far rejected moves to embrace European systems. Nevertheless, with intensified market integration and the increasing influence of Anglo-American investors, it is arguable that the market will play a significant role. Nevertheless, the attractiveness of the Anglo-American finance and governance institutions permeated with inequality and vulnerability to recurrent severe market cycles and crisis puts it at stake. After all, the damaging consequence of the 2008 financial crisis severely affected global business. It consequently dislodged the faith that the market-based governance system is the only rational and crisis-proof system. Relative strengths and weaknesses The market-based system is much more reliant on a well-defined property rights system supported by legal enforcement relative to the bank-based system (Thomas, 1994). It presents an explanation to why most transitioning economies are opting to adopt the bank-based system. The bank-based systems are known to reduce agency and monitoring costs that typically affect the cost of capital. The market-based system receives criticism for making fund-raising very expensive for firms undergoing stringent informational asymmetric. Thus, it is possible to argue that financing exhibits the double-edged properties of the free cash flow proposed by theorists. Scholarships claim that the accumulation of internal finances is essential if a firm is subject to serious financing limitations. Contrarily, direct opportunities the finds might, however, to excessive and unproductive investments by the management. The bank-based system is also vulnerable to this scenario of the close relation between firms and banks reduce the cost of capital substantial as internal agency costs coupled with the claim that information asymmetries may still linger. The pursuance of growth sometimes leads to over-investment. Since the interest of banks is mostly relationship-related, the budget limitation in bank-based systems may be softer compared to the market –based system. Arguably, bank-based systems enhance long-term and relationship specified investment though the shortermanism is a challenge for the system. Replacement threats might drive managers to seek quick fixes to satisfy stakeholders, however, the move negatively affects innovation and ultimately reduces the incentives to invest in relationship-specific capital. Differences in the Financial Systems and 2008 Crisis The significant difference between the security-based and bank-based financial systems is that one is decentralised while other centralised. The centralised system can quickly mobilise financing towards a large scale and long-term projects for future results. However, it is not suitable for evaluating or financing short and medium term risky projects. A decentralised system places price tags project, via stock market pricing, but the risk is transferred to the investors, not born by intermediaries comprising of banks; the typical scenario of the 2008 crisis (Hasan & Turan, (2013, 435). Despite the securities-based system's risk being priced by the market itself, the institution-based system's investment projects are usually evaluated by the banks that have the conservative attitude towards the risk taking business. The costs and probability of failure are much increased in the U.S. system, despite the prospects of and the benefits emanating from the risky projects being great (Hasan & Turan, 2013).. Lessons from the 2008 Crisis The 2008 inflation was brought down via banking activities to reasonable levels; activities associated with the processing of decreased payments. Moreover, in the 2008 crisis there was higher shares of total non-equity liabilities in the assets in Germany and Japan as in comparison to the U.S. and UK. The result, which is 57-74% versus the 47-60%, the assets to debts indicators were lowest for the U.S. and the UK, 13% and 5% as compared to 20-35% for Japan and Germany (World Bank, 2010). Again, it is emergent that deficiencies in regulation are dangerous and so is overregulation. States should desist from the regulation of the free market choices, rather, regulations should incline to the protection of investors and corporates against the conflicts of interests and negligence by bankers. The regulation should advocate total transparency and disclosures. Conclusions Finding the exact economic system that operates to produce a conducive environment for the proper corporate governance is still a debatable issue. Karl Marx claimed that the market economy is inherently unequal and unjust since power shifts to the hands of the owners of capital. Further, studies concur that the free market is unable to respond adequately to major recessions. The recent global recession that hard hit most global economies supports this criticism. Major global business reported drops in sales and revenues leading to massive job cuts and foreclosures as debts continued to pile. The ability of a country to resist a crisis relies on the Spatio-temporal fixes a country has in place. The fixes exist to cushion the effects of the crisis, transfer the crisis to other nations or defer the consequences to the future. The configurations of corporate governance can function as institutional fixes when placed within an appropriate institutional environment that permits benefited complementary. The fact that a country like Germany successfully resisted the recession relative to others calls for studies to ascertain how effective the system is. 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