Sunteți pe pagina 1din 13

(Allen & Carletti, 2008) (Allen & Gale, 1997) (Beck & Levine, 2002) (Durnev, et al.

,
2004) (Levine, 2002) (Levine, 2002) (Levine & Zervous, 1998) (Stiglitz, 1985) (Bailey,
2005) (Bain, 2007)
Q.
By critically reviewing the arguments and evidence presented in the literature,
determine whether developing economies should use market-based or institutionbased approaches to the allocation of capital to the corporate sector.
Answer:

Developing economies are more related to the countries where the standard of living
are lower than so called developed countries. Industries are also very less in
developing countries compared to developed countries. Other factors like population,
education, technology and infrastructure of the nation also reveals how developed
the nation is and the economy.
Every developing nation is moving towards the growth and expansion so that it meet
its all requirements to become a developed and wealthy nation. Achieving such a
target is not a easy thing. Every economic aspect is related to the industries and the
workforce. A key question in development economics is the relation between a
countrys financial system and its economic development.
Developing countries need to apply certain approach to fulfill the investment needs.
To allocate the capital in a corporate sector various ways of approach can be
identified. Among them market based and institution based are the main approaches
developing countries are using at this context.
Outlining what are the market and the institution based approaches lets first take
some of the examples of both the approaches:
Among the main kinds of markets are the following
Stock Markets

Bond Markets
Various kinds of Derivatives Markets Futures Markets, Swap Markets, Forward
Markets, Options Markets
Foreign Currency Markets
Markets which are not solely financial markets but which involve buying and selling
something for use as an asset for example commodity markets
Money Markets
Among the main kinds of institution are the following
Banks (both commercial and investment banks)
Insurance Companies
Various kinds of investment managers or funds pension funds, money market
funds, private equity funds, sovereign wealth funds, mutual funds (unit trusts in the
UK), exchange traded funds, hedge funds
Building societies (or savings and loan associations in the USA)
Various kinds of regulators central banks, other regulators such as the SEC in the
US and FSA in the UK
International financial institutions the World Bank, Asian Development Bank,
European Bank for Reconstruction and Development, Bank for International
Settlements and so on
The main conclusion that can be drawn from the answer is that the world of financial
institutions and markets is very varied and complex, so that we need to start by
simplifying our analysis down with some basic models and then introduce more and
more of the reality gradually.
There is also a view that various economic developments have led to an increased
importance for finance for example the move towards floating exchange rates after
1971 led to an increase in international capital flows and to the development of new

financial instruments to allow companies to hedge against exchange rate risk. The
problem is that the financial sector now absorbs an awful lot of highly skilled labour
which could be used for other purposes. Some observers like Adair Turner (former
chair of the Financial Services Authority in the UK) have argued that this is
undesirable and that many of the activities of the financial sector have little social
value compared with the cost of the resources (especially human resources) needed
to undertake them. It is hard to find a definite answer to the question about what the
optimal size of the financial sector should be but one key point to note is that over
the years the value of the financial sector to society has increasingly come to be
judged in terms of how well it allows society to manage risk.
A process of how businesses divide their financial resources and other sources of
capital to different processes, people and projects. Overall, it is management's goal
to optimize capital allocation so that it generates as much wealth as possible for its
shareholders.

The process behind making a capital allocation decision is complex, as management


virtually

has

an

unlimited

number

of

options

to

consider.

For example, if a company ends up with a larger than expected windfall at the end of
the year, management needs to decide whether to use the extra funds to buy back
stock, issue a special dividend, purchase new equipment or increase the research
and development budget. In one way or another, each one of these actions will likely
benefit the shareholder, but the difficult part is in determining how much money
should be allocated to each action in order to yield the most benefit.

To finance the expansion of the industries and to facilitate the formation of new
establishment and improving the capital allocation across the industries one should
take a better approach to meet its requirements. Here in this essay we will discuss
about market based and bank based financial systems to approach and its positives
and negative aspects to the nation and the companies.

Financial institutions have a number of purposes. Important ones are the following
To move funds from providers of funds (who have surplus funds available) to users
of funds (who need more funds)
To allocate capital efficiently in line with the preferences of providers and users with
regard to risk and return
To allow opportunities for diversification to reduce risk
To allow providers and users to smooth consumption over time through borrowing
and lending
To mobilise funds for productive investment to encourage economic growth
Financial markets have the same purposes but they also have an extra purpose
which is important
To value assets correctly and spread this information through the financial system
The main stakeholders are households as the chief providers of funds and nonfinancial companies and the government as the chief users of funds. In addition,
those who work in financial institutions are potentially important stakeholders and
there is an important question about how returns from such institutions are to be
divided between them and the owners of the institution (shareholders).
Older theories of finance tended to emphasise the choice between using markets or
institutions as the basis for financial transactions in developing economies. More
recently, however, a number of writers have argued that this is a false choice
because financial institutions need markets in order to function effectively and
financial markets also depend upon institutions to work well.
Among the possible ways we could mention are the following
Institutions are among the largest participants in financial markets

Markets themselves can be seen as institutions (for example stock exchanges are
themselves companies with shareholders who engage in merger and acquisition
activity)
Institutions provide a lot of the liquidity which enables markets to function smoothly
Some institutions such as central banks regulate markets
Many of the financial innovations (e.g. derivatives) that have led to new markets
originated in institutions
Developing economies tends to copy what the developed economy has done. one of
the main activities of financial markets and institutions is the buying and selling of
financial assets and we will spend quite a lot of time in this module looking at the
pricing of assets.
Over the last two decades the financial sector has taken on an increasingly large role
in the main industrialised economies. Rise in the importance of finances has been
attributed by some to globalisation (which has reduced the share of manufacturing in
the OECD countries as production has been shifted elsewhere), to technological
change which has lowered the value of manufacturing products and to deregulation
which has encouraged financial activity to spread and has led to financial innovation.

Financial intermediaries can improve the acquisition of information on firms, the


intensity with which creditors exert corporate control, the provision of risk-reducing
arrangements, and the mobilization of capital. This is an argument in favor of welldeveloped banks. It is not, however, an argument in favor of a bank-based financial
system. The case for a bank-based system, instead, comes from a critique of the
role of markets in providing financial service. Stiglitz (1985) argues that since welldeveloped markets quickly reveal information to investors at large, this dissuades
individual investors from spending much time and money researching firms. There is
a basic free-rider problem. This problem is less severe in bank-based systems since
banks can make investments without revealing their decisions immediately in public
markets. Furthermore, banketeers argue that markets are an ineffective device for
exerting corporate control.

First, insiders probably have better information about the corporation than outsiders
do. This informational asymmetry mitigates the potential effectiveness of takeovers
since it is less likely that ill-informed outsiders will outbid relatively well-informed
insiders for control of firms (unless they pay too much!).
Second, liquid equity markets may facilitate takeovers that while profiting the raiders,
may actually be socially harmful [Shleifer and Summers 1988].
Third, more liquidity may reduce incentives to undertake careful and expensive
corporate governance. By reducing exit costs, stock market liquidity encourages
more diffuse ownership, such that each owner has fewer incentives to oversee
managers actively [Shleifer and Vishny 1986].
Fourth, if an outsider expends lots of resources obtaining information, other market
participants will observe the results of this research when the outsider bids for
shares of the firm. This will induce others to bid for shares, so that the price rises.
Thus, the original outside firm that expended resources obtaining information must,
therefore, pay a higher price for the firm than it would have to pay if free-riding firms
could not observe its bidding. The rapid public dissemination of costly information
reduces incentives for obtaining information and making effective takeover bids.
Fifth, existing managers often take action poison pills which deter takeovers and
thereby weaken the market as an effective disciplining device. There is some
evidence that, in the United States, the legal system hinders takeovers and grants
considerable power to management. Fifth, although shareholder should be able to
control management through boards of directors, an incestuous relationship may
blossom between boards of directors and management. Members of a board enjoy
their lucrative fees and owe those fees to nomination by management. Thus, boards
are more likely to approve golden parachutes to managers and poison pills that
reduce the attractiveness of takeover. This incestuous link may further reduce the
effectiveness of the market for corporate control [Allen and Gale 1999].
In sum, proponents of bank-based systems argue that there are fundamental
reasons for believing that market-based systems will not do a good job of acquiring
information about firms and overseeing managers. This will hurt resource allocation
and economic performance. Banks do not suffer from the same fundamental
shortcomings as markets; they will do a correspondingly better job at researching
firms and overseeing managers. Furthermore, while markets may potentially provide

the best tailor-made products for hedging risk, markets are imperfect and
incomplete. Thus, in some circumstances particularly involving intertemporal risk
sharing bank-based systems may offer better risk ameliorating services than
market-based systems [Allen and Gale 1999].
We concentrate on corporate debt in emerging markets since firms in these markets
depend heavily on
bank debt due to limited development of public debt markets. Therefore, domestic
banking sector reforms should have a significant impact on the corporate leverage
decisions in these markets. Using a detailed
measure of banking sector reforms and a large panel of non-financial firms in
emerging markets during the period 19902002, we find that firms carry less (bank)
debt in their capital structure following
banking sector reforms. The evidence is consistent with the notion that these reforms
foster efficient credit market development, which results in higher costs of bank
funding, better pricing of risk, tightened lending standards and more stringent bank
supervision.
Market-Based System The case for a market-based system is essentially a
counterattack focusing on the problems created by power banks. Bank-based
systems may involve intermediaries with a huge influence over firms and this
influence may manifest itself in negative ways. For instance, once banks acquire
substantial, inside information about firms, banks can extract rents from firms; firms
must pay for their greater access to capital. In terms of new investments or debt
renegotiations, banks with power can extract more of the expected future profits from
the firm (than in a market-base system). This ability to extract part of the expected
payoff to potentially profitable investments may reduce the effort extended by firms to
undertake innovative, profitable ventures [Rajan 1992]. Banks (as debt issuers) also
have an inherent bias toward prudence, so that bank-based systems may stymie
corporate innovation and growth. Weinstein and Yafeh (1998) find evidence of this in
Japan. While firms with close to ties to a main bank have greater access to capital
and are less cash constrained than firms without a main bank, the main bank firms
tend to (i) employ conservative, slow growth strategies and do not grow faster than
firms without a main bank, (ii) use more capital inventive processes than non-main
bank firms holding other features constant, and (iii) produce lower profits, which is
consistent with the powerful banks extracting rents from the relationship. Allen and
Gale (1999) further note that although banks may be effective at eliminating
duplication of information gathering and processing, which is likely to be helpful
when people agree about what needs to be gathered and how it should be
processed, bank may be ineffective in non-standard environments. Thus, banks may
not be effective gatherers and processors of information in new, uncertain situations
involving innovative products and processes. Another line of attack on the efficacy of

bank-based systems involves corporate governance. Bankers act in their own best
interests. Bankers may become captured by firms, or collude with firms against other
creditors. Thus, influential banks may prevent outsiders from removing inefficient
managers if these managers are particularly generous to the bankers [Black and
Moersch 1998a]. Wenger and Kaserer (1998) provide convincing evidence for the
case of Germany. In Germany, bank managers voted the shares of a larger number
of small stockholders. For instance, in 1992, bank managers exercised on average
61 percent of the voting rights of the 24 largest companies and in 11 companies this
share was higher than 75%. This control of corporations by bank management
extends to the banks themselves! In the shareholder meetings of the three largest
German banks, the percentage of proxy votes was higher than 80 percent, much of
this voted by the banks themselves. For example, Deutsche Bank held voting rights
for 47 percent of its own shares, while Dresdner votes 59 percent of its own shares
[Charkham 1994]. Thus, the bank management has rested control of the banks from
the owners of the banks and also exerts a huge influence on the countrys major
corporations. Wenger and Kaserer (1998) also provide examples in which banks
misrepresent the accounts of firms to the public and systematically fail to discipline
management. 16 Finally, market-based financial systems provide a richer set of risk
management tools that permit greater customization of risk ameliorating instruments.
While bank-based systems may provide inexpensive, basic risk management
services for standardized situations, market-based systems provide greater flexibility
to tailor make products. Thus, as economies mature and need a richer set of risk
management tools and vehicles for raising capital, they may concomitantly benefit
from a legal and regulatory environment that supports the evolution of market-based
activities, or overall growth may be retarded.
Imp frm here

,,,,,The financial services view notes that markets and banks may

provide complementary services or provide the same financial services. For


instance, stock markets may positively affect economic development even though
not much capital is raised through them. Specifically, stock markets may play a
prominent role in facilitating custom-made risk management services and boosting
liquidity. In addition, stock markets may complement banks. For instance, by spurring
competition for corporate control and by offering alternative means of financing
investment, securities markets may reduce the potentially harmful effects of
excessive bank power. 17 While the theoretical literature is making progress in
modeling the co-evolution of banks and markets [Boyd and Smith 1996; Allen and
Gale 1999], there is already some empirical evidence. For instance, (Levine & Sara,

1998)Levine and Zervos (Levine & Zervous, 1998) (1998) show that greater stock
market liquidity implies faster economic growth no matter what the level of banking
development. Similarly, greater banking development implies faster growth
regardless of the level of stock market liquidity. Moreover, even after controlling for
other country characteristics, such as initial income, schooling, political stability,
monetary, fiscal, trade, and exchange rate policies, the data still indicate that both
banking development and stock market development exert a positive influence on
growth. Using firm-level data, Demirguc-Kunt and Maksimovic (1996) show that
increases in stock market development actually tend to increase the use of bank
finance in developing countries. Thus, these two components of the financial system
may act as complements during the development process. We may not want to view
bank-based and market-based systems as representing a tradeoff. Policymakers
may instead want to focus on providing a legal and regulatory environment that
allows both banks and markets to flourish without tipping the playing field in favor of
either banks or markets.
The bankbased view holds that bank-based systems particularly at early stages of
economic development foster economic growth to a greater degree than marketbased financial system. In contrast, the market-based view emphasizes that markets
provide key financial services that stimulate innovation and long-run growth.
Alternatively, the financial services view stress the role of bank and markets in
research firms, exerting corporate control, creating risk management devices, and
mobilizing societys savings for the most productive endeavors. This view minimizes
the bank-based versus market-based debate and emphasizes the quality of financial
services produced by the entire financial system. Finally, the legal-based view rejects
the analytical validity of the financial structure debate. The legal-based view argues
that the legal system shapes the quality of financial services. Put differently, the
legal-based view stresses that the component of financial development explained by
the legal system critically influences longrun growth. Thus, we should focus on
creating a sound legal environment, rather than on debating the merits of bankbased or market-based systems. The cross-country data strongly support the
financial services view of financial structure and growth, while also providing
evidence consistent with the legal-based view. The data provide no evidence for the
bank-based or market based view. Distinguishing countries by financial structure
does not help in explaining cross-country differences in long-run economic
performance. Distinguishing countries by their overall level of financial development,
however, does help in explaining cross-country difference in economic growth.

Countries with greater degrees of financial development as measured by


aggregate measures of bank development and market development are strongly
linked with economic growth. Moreover, the component of financial development
explained by the legal rights of outside investors and the efficiency of the legal
system is strongly and positively linked with long-run growth. The legal system
importantly influences financial sector development and this in turn influences longrun growth. Although the measures of financial structure are not optimal, the results
do provide a clear picture with sensible policy implications. Improving the functioning
of markets and banks is critical for boosting long-run economic growth. Thus, policy
makers should focus on strengthening the legal rights of outside investors and the
overall efficiency of contract enforcement. There is not very strong evidence,
however, for using policy tools to tip the playing field in favor of banks or markets.
Instead, policy makers should resist the desire to construct a particular financial
structure. Rather, policy makers should focus on the fundamentals: property rights
and the enforcement of those rights

An institutional environment that protects private property rights appears to be an


important precursor to economic growth. In part, this seems to be because property
rights protection in general, and shareholder rights in particular, promote informed
risk arbitrage in stocks. This, in turn, leads to asynchronous stock prices, which
serve as important signals for efficient capital allocation. A higher quality of capital
allocation ultimately leads to higher productivity and faster economic growth. This
has direct implications for transition economies. Many transition economies have
established stock market, hoping these can stimulate and sustain economic growth
in the long term. Stock markets can support economic growth by processing
information so as to allocate the economys capital efficiently. Lower stock prices
raise the cost of capital to firms that are poorly-run, reduce stock options
compensation to under-performing managers, set a barrage of corporate governance
mechanisms in motion, and provide feedback to managers to help them avoid further
mistakes. The results surveyed here suggest that simply having a stock market per
se is unlikely to either stimulate or sustain economic growth. This is because stock
markets allocate capital poorly unless they are teeming with informed investors, who
gather and process information about companies and use this to undertake profitable
risk arbitrage. Stock returns in many low-income economies, including many
economies in transition, tend to move very synchronously. That is, the stock markets
in these countries do little to channel capital towards high quality firms and away

from low quality firms. In general, these countries seem to be doing little to improve
the functioning of their stock markets. This may be the result of political rent-seeking
by economic insiders, who rationally view a well-functioning financial system, and
especially a well-functioning stock market, as capable of raising up 52 competitors
and innovators who threaten the status quo. Consequently, protecting outsiders
property rights not only limits insiders freedom of action, it threatens their very power
and privilege. Granting effective rights to outside shareholders is especially perilous.
There is thus a real danger that some transition economies are replacing economic
dictatorship by communist bureaucrats for economic dictatorship by a small clique of
politically

well-connected,

entrenched

insiders.

These

insiders

use

their

connections to get rich in the early stages of transition. They then establish
pyramidal corporate groups to sidestep poorly functioning markets and expand their
control over the economys resources. Once this control is achieved, the elite
undertakes political rent-seeking to lock in their control. This rent-seeking aims to
limit outsiders property rights, to undermine capital markets that might finance
upstarts, and to isolate the economy from foreign capital and competition. It induces
capital misallocation, prolonged slow growth, and a lack of upward economic mobility
for late comers. Consequently, the rise of politically connected oligarchs and their
current construction of pyramidal corporate groups in many transition economies is a
cause for deep concern. Once large corporate pyramid groups become entrenched,
reversing the economic entrenchment that hinders economic growth will be very
difficult. Finally, economic openness in general, and openness to financial flows in
particular, are ways of circumventing these problems. Local competitors and
innovators can obtain foreign financial backing, and foreign competitors can enter
the local market. Under these circumstances, rent-seeking to undermine the local
financial system is, at best, pointless to insiders. Although free capital flow is often
condemned as a source of macroeconomic instability, protectionism in finance has
the even more unattractive consequences discussed above. Transition economies
should conduct responsible macroeconomic and financial policies to avoid financial
crises. Barriers against global financial markets are probably very expensive
prophylactics.
Banks perform various roles in the economy. First, they ameliorate the information
problems between investors and borrowers by monitoring the latter and ensuring a
proper use of the depositors funds. Second, they provide intertemporal smoothing of
risk that cannot be diversified at a given point in time as well as insurance to
depositors against unexpected consumption shocks. Because of the maturity

mismatch between their assets and liabilities, however, banks are subject to the
possibility of runs and systemic risk. Third, banks contribute to the growth of the
economy. Fourth, they perform an important role in corporate governance. The
relative importance of the different roles of banks varies substantially across
countries and times but, banks are always critical to the financial system. (Allen &
Carletti, 2008).
Economists have long debated the advantages and disadvantages of
bank-based financial systems vis--vis market-based systems.1 This
debate has primarily focused on four countries. In bank-based financial
systems such as Germany and Japan, banks play a leading role in
mobilizing savings, allocating capital, overseeing the investment decisions
of corporate managers, and in providing risk management vehicles. In
market-based financial systems such as England and the United States,
securities markets share center stage with banks in terms of getting
societys savings to firms, exerting corporate control, and easing risk
management. Some analysts suggest that markets are more effective at
providing financial services. Others tout the advantages of intermediaries.
The debate is unresolved and hampers the formation of sound policy
advice. There is a major shortcoming with existing comparisons of marketbased versus bankbased financial systems; they focus on a very narrow
set of countries with similar levels of GDP per capita, so that the countries
have very similar long-run growth rates. Thus, if one accepts that
Germany and Japan are bank-based and that England and the United
States are marketbased and if one recognizes that these countries all
have very similar long-run growth rates, then this implies that financial
structure did not matter much.2 To provide greater information on both
the economic importance and determinants of financial structure,
economists need to broaden the debate to include a wider array of
national experiences

Bibliography
Allen, F. & Carletti, E., 2008. The Roles of Banks in Financial Systems:
(Wharton School Working Paper). [Online]

Available at: http://fic.wharton.upenn.edu/fic/papers/08/0819.pdf


[Accessed 01 12 2015].
Allen, F. & Gale, D., 1997. Financial Markets, Intermediaries, and
Intertemporal Smoothing. Journal of Political Economy, 105(3), pp. 523546.
Beck, T. & Levine, R., 2002. Industry growth and capital allocation: does
having a market- or bank-based system matter?. Journal of Financial
Economics, 64(2), pp. 147-180.
Durnev, A., Li, K., Morck, R. & Yeung, B., 2004. Capital Markets and Capital
Allocation. Implications for Economics of Transition, 12(4), pp. 593-634.
Levine, R., 2002. Bank-Based or Market-Based Financial Systems:Which Is
Better?. Journal of Financial Intermediation 11, pp. 398-428.
Levine, R. & Zervous, S., 1998. Stock markets, banks, and economic
growth. American Economic Review, Volume 88, pp. 537-538.
Stiglitz, J., 1985. Credit markets and the control of capital. J. Money, Credit
Banking 17, pp. 133-152.

S-ar putea să vă placă și