financial environment alternative types of financial sector organization (c) 2015 melvin h jameson

Financial EnvironmentAlternative types of financial sector organization

(C) 2015 Melvin H Jameson

Functions of a financial system:Payment system - facilitate trade

Link savers and borrowers●Allocation of capital - investment decisions●Corporate governance - control within the enterprise


Alternative forms of financial sectorArise from alternative approaches to its tasks for example allocation of investment capital

●Direct government allocation of all resources, =command economy●Examples:

Soviet Union, North Korea, Maoist China


Internal effects - command●All production by state-owned enterprises

following the central plan●Banks provide financing where directed by

plan●Payment system not too different from market

systemConsequences

●Money, prices and interest rates viewed only as a means of account, not a means of allocation. Thus they need not reflect relative scarcity.

●Currency is non-convertible.●Governance is a political function (managers

appointed)(C) 2015 Melvin H Jameson

Implications for MNE - command●Very limited opportunities for activity and

tightly controlled by and negotiated with host government●Trade:

● Limited to products deemed essential by host government

●Investment: even more limited

●Problems in realizing revenue or profit●Internal markets controlled, currency non-

convertible● Host government approval of FX for purchases

deemed essential● Barter arrangements [Pepsi in Soviet Union]


Alternative: hybrid systemDirected growth but without trying to plan the entire economy●Investment (capital allocation) government directed.●Production left to market forces and private enterprise

Examples:●Japan (post WWII) ●S. Korea ●China today (with both private and SOEs, “dual

track”) (C) 2015 Melvin H Jameson

Internal implications - hybrid●Producers respond to market●Banks lend following government guidanceConsequences

●“Financial repression” – distorted capital markets● Savers offered artificially low interest rates● Non-favored borrowers lack access to capital● Creates pressure for a grey market (shadow

banking)● Requires currency controls to maintain

●Corporate governance can be more lender oriented than shareholder oriented.(C) 2015 Melvin H Jameson

Implications for MNE - hybrid●Trade

●Product market functions normally●Currency convertible for trade purposes

●Investment: ●Limited to highly controlled ventures negotiated

with host government●Capital account cash movements limited and

subject to approval

●Problems in realizing revenue or profit●currency non-convertible for capital acct.

● Host government approval of FX required


Alternative: weak market infrastructure

Not policy as much as underdeveloped institutions●Legal system

●Legal rights available●Enforceability of legal rights

●Quality, cost and availability of information●Thin markets/high transaction costs

Examples: many emerging markets


Internal implications: weak institutions

Generally limit access to external capital●Legal system

●Weak shareholder rights limit equity●Weak creditor rights limit lending

●Lack of information discourages external investment●High transaction costs do the sameCreate incentive to avoid markets and contracts

●Conglomerate groups, often family controlled●Personal relationships very important


Internal implications: weak institutions

Create an incentive to avoid markets and contracts

The financial system adapts in response●Conglomerate groups, often family controlled●Personal relationships very important


Some types of market financial systems

Financial market emphasisAnglo-American system

Bank emphasisGerman system

(Family) Group structureJapan: Zaibatsu → KeiretsuKorea: ChaebolLatin America, SE Asia etc.


Financial system and legal system

Market system Requires strong legal system, enforceable

contracts- bankruptcy rules- minority shareholder rights

Bank systemLegal system available, but more

relationship based

GroupsAn “internal capital market” substitutes for

enforceable external legal contracts(C) 2015 Melvin H Jameson

Implications for the MNE●Potential Opportunity

Underdeveloped local financial markets can be an advantage for the MNE with (reasonably) open access to world markets.

●Potential ChallengesUnderdeveloped local markets are often combined with financial repression limiting access to world markets or the corporate parent.


Quality of legal environmentinfluences the financial system

●General rule of law Enforceability of contracts affects all areas; particularly finance

●Creditor rightsIf weak inhibit banking and all lending

●Shareholder rightsIf weak inhibit equity markets; lead to concentrated ownership


Market infrastructure

Rule of Law●Accounting standards●Efficiency of legal system●Corruption●Will the government repudiate contracts



Creditor rights●Does a reorganization require creditor consent?●Do secured creditors rank first in asset

distribution? ●Does an automatic stay prevent secured

creditors from seizing their security during the bankruptcy process?

●Does debtor control assets during the legal process?



Shareholder rights●Are all shares entitled to one and only one

vote?●Is proxy voting by mail allowed?●Is cumulative voting (all my votes for one

director) or proportional board representation of minorities allowed

●Do minority shareholders have a judicial venue to challenge board decisions?

●Do existing shareholders have a preemptive right to purchase new stock issues?


Alternative: minor interventionIntended to benefit politically favored group or industry, for example “industrial policy”●Taxes or subsidies

Consequences●Relatively minor distortions●Requires only limits on who benefits


Alternative: major interventionIntended to benefit politically favored group or industry●Direct government spending●Nationalization of select industriesConsequences

●Price controls●Generally requires currency controls as well●In extreme cases can lead to partial collapse of

the market system.


Zimbabwe1994: 25%1998: 48%2002: 199%2006: 1,281%

●August 2006: 1st redenomination ZWD$1,000 → ZWN$12007: 66,212%

●August 2008: 2nd redenomination ZWN$10b → ZWR$1Dec. 2008 (estimate): 6.5x10108 % or 91% per day

●March 2009: Zimbabwe dollar suspended: informal (U.S.) dollarization


Discussion: Venezuela

●Price controls●Currency controls●Rampant

smuggling


Implications for MNE – intervention

●Interference in domestic market such as price controls

●Currency blockage

●MNE may better placed to meet resulting funds transfer challenge than other firms.


financial environment alternative types of financial sector organization (c) 2015 melvin h jameson

Documents