Ngân hàng, tín dụng - Chapter 16: Financial system design

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 16 Financial System Design Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-2 Learning Objectives • Analyze the stockholder-lender and manager- stockholder conflicts • Understand the different financial structures that limit these conflicts • Compare and contrast the financial system design of Germany, Japan, the United Kingdom, and the United States Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-3 Introduction • As Eastern European countries adopt capitalism, they are faced with task of designing a financial system • Two models in industrialized nations are: – Markets-oriented—United States and United Kingdom – Banking-oriented—Germany and Japan • Chapter examines/contrasts the two models • Ends with observations/recommendations for emerging capitalistic countries 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-4 Information and System Design • All financial systems have things in common – Payments system—processing of checks and electronic transfers – Specialized Financial Intermediaries — organizations or activities designed to perform specific functions within the financial system – Deposit Insurance—protecting individual depositor – Central Bank—responsible for issuing currency and implementing monetary policy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-5 Information and System Design (Cont.) • However, there are significant differences – Primarily related to how businesses obtain financing – The private ownership of business leads to two fundamental problems that are handled differently by the financial sectors in the various systems • Both are based on the issue of asymmetric information • Stockholder-lender conflict • Management-stockholder conflict Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-6 Information and System Design (Cont.) • Stockholder-Lender Conflict – Adverse selection—firm owners (stockholders) have an incentive to understate their true riskiness to obtain borrowing on a more favorable basis – Moral hazard—firms have an incentive to become riskier after their loans are funded – Magnitude of these two problems is much less for large companies because of large amounts of publicly available information 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-7 Information and System Design (Cont.) • Manager-Stockholder Conflict – This conflict presents a much greater problem with large companies – Stockholders (owners) delegate the management to professional managers – Owners would like the manager to operate the firm in their best interest—maximize value of the stock Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-8 Information and System Design (Cont.) • Manager-Stockholder Conflict (Cont.) – Unfortunately, the manager may have other objectives • Minimize their own effort and maximize their salaries and perks • May want to maximize the firm’s size to increase their importance • Want to preserve their jobs which suggests choosing excessively safe strategies rather than value-maximizing strategies that may involve more risk Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-9 Information and System Design (Cont.) • Manager-Stockholder Conflict (Cont.) – Firing the manager is one way to resolve the differences between stockholders and managers • This requires close monitoring of their performances • Difficult to judge whether an activity is in the best interest of the stockholders • Might prove difficult and costly • Since there are often a large number of stockholders, they may be no incentive for any individual to monitor the performance 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-10 Information and System Design (Cont.) • Manager-Stockholder Conflict (Cont.) – Small, closely held firms this conflict is less • A significant amount of stock is held by one investor • Major stockholder has a great incentive to monitor the manager’s performance • Potential gains of monitoring the performance is much greater than the costs • The owner in a closely held firm often has the power to control the firm’s board of directors and fire managers • In privately held firms, the owner is often the manager--eliminates the stockholder-manager conflict Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-11 Information and System Design (Cont.) • Conflict Resolution and Financial System Design – Figure 16.1 summarizes the relationship between firm size and the two problems just discussed – Stockholder-lender conflict (risk-shifting problem) is significant for small firms, but not large ones – Manager-stockholder conflict (corporation governance)—does not arise for small firms, but exists for large firms with professional managers Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-12 FIGURE 16.1 Financial system design: the problems. 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-13 Information and System Design (Cont.) • Conflict Resolution and Financial System Design (Cont.) – These two conflicts are associated with external financing—almost all firms raise funds from outsiders in the form of debt or equity – These two conflicts are dealt with differently in a banking-oriented financial system as compared to a markets-oriented financial system Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-14 Information and System Design (Cont.) • Conflict Resolution and Financial System Design (Cont.) • Banking-oriented—banks actually own companies they monitor, and the stock and bond markets are relatively underdeveloped • Markets-oriented—banks do not own companies and public bond and stock markets are prominent institutions • Figure 16.2 summarizes how banking-oriented systems (a) and markets-oriented systems (b) solve the stockholder-lender and manager-stockholder conflicts Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-15 FIGURE 16.2 Financial system design: conflict resolution. 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-16 Information and System Design (Cont.) • Small Firms: Stockholder-Lender Conflict – Both systems treat small firms similarly – Small firms borrow from banks and other monitoring- intensive financial intermediaries – Banks are specialists in information--ideally suited to assess borrower risk before making the loan – Design loan contracts to minimize the incentive to become riskier after the loan is made • Small firms: Manager-Stockholder Conflict – Not a problem in either financial system Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-17 Information and System Design (Cont.) • Large firms: Stockholder-Lender Conflict – The two financial systems treat large firms significantly differently – Markets-Oriented System • Large firms tend to borrow short term in commercial paper market and borrow long term in the bond market • Production of information about business risk is delegated to bond rating agencies • Widespread availability of public information, plus credit ratings, enables large firms to develop reputation for not becoming too risky Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-18 Information and System Design (Cont.) • Large firms: Stockholder-Lender Conflict (Cont.) – Banking-Oriented Systems • When lender and stockholders are the same (the bank), as is often the situation, this problem does not exists • No incentive for stockholder to exploit themselves • However, it is generally not the case that banks own all of the firm’s equity • Nevertheless, consolidation of ownership is often large enough that the bank owns a controlling interest 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-19 Information and System Design (Cont.) • Large Firms: Manager-Stockholder Conflict – Banking-Oriented Systems • Solution is driven principally by the bank’s ownership of the business • Bank has the incentive to monitor the behavior of the firm’s management • Bank also has control over management so it can fire an incompetent manager Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-20 Information and System Design (Cont.) • Large Firms: Manager-Stockholder Conflict (Cont.) – Markets-Oriented Systems • Because of diffuse ownership, little incentive for individual stockholders to monitor performance of managers • Often the CEO will influence who is selected to serve on the board of directors, which results in ignoring the CEO’s poor performance • Creates a distinct possibility that inefficient managers become entrenched and the firm becomes manager-controlled Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-21 Information and System Design (Cont.) • Large Firms: Manager-Stockholder Conflict (Cont.) – Markets-Oriented Systems (Cont.) • Often this situation is resolved through a corporate takeover and new owners replace previous managers • Managers will actively resist such a takeover effort • Hostile takeover—attempts to takeover a company against current management’s wishes • To minimize the conflict, management’s compensation packages are structured to link compensation to performance desired by stockholders 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-22 Financial System Design: Summary of Four Countries • Germany – A strong banking-oriented financial system – Hausbank • A single bank that is the primary source of external financing, both debt and equity • The relationship between a business firm and their Hausbank is a very powerful one • This relationship fosters bank participation in the strategic activities of the firm through stock ownership and control, and sitting on company supervisory boards Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-23 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) – Hausbank (Cont.) • Bank ownership participation is both direct and indirect – Direct—bank owns a large share of the stock – Indirect—individuals and institutions deposit stock holdings in a trust account with a bank and voting rights are conveyed to the bank Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-24 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) – Organization of the banking system • Commercial banks – Comprised of three major banks and a number of regional and private banks – Active participants in the international markets • Savings banks – Typically owned by regional or town government which operate locally – Initially organized as mortgage lenders but now offer full commercial banking services 9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-25 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) – Organization of the banking system (Cont.) • Cooperative banks – First established to collect savings and extend credit to individuals • Specialized banks – Mortgage, consumer lending, small business loan guarantees, export financing, and industry-specific financing Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-26 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) – Dominance of banks in Germany comes at the expense of the securities markets • Stock, bond, and commercial paper markets are not very important • Eight regional stock exchanges, dominated by the Frankfurt exchange • Less than a quarter of the largest German companies are listed, and a large proportion are not actively traded Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-27 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) • Corporate bond and commercial paper market is very small, largely due to taxes and regulations prior to 1992 making it very expensive to issue these securities • Therefore, most German companies are highly dependent on their banks for credit 10 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-28 Financial System Design: Summary of Four Countries (Cont.) • Germany (Cont.) – Dominance of banking system is aided by regulations that permits universal banking • Can engage in a variety of financial service activities • Permitted to own nonfinancial companies and underwrite corporate securities and insurance • Those who advocate giving U.S. banks full underwriting privileges cite German universal banking as model of success • However, this success might be a result of a poorly developed stock and bond market which is not the case in the United States Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-29 Financial System Design: Summary of Four Countries (Cont.) • Japan – Keiretsu form of industrial organization • A group of companies that are controlled through interlocking ownership—companies own stock in each other • Encourages strong loyalty among the companies, including favoritism in customer-supplier relationships • Each keiretsu has a main bank that typically owns stock in other members of the keiretsu Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-30 Financial System Design: Summary of Four Countries (Cont.) • Japan (Cont.) – Japanese banks may own equity in nonfinancial companies, although this is now limited to 5 percent in any single firm – Organization of the banking system • City banks—represent a disproportionately large fraction of the world’s biggest banks • Regional banks • Special-purpose financial institutions—include long-term credit banks, specialized small business and industrial institutions 11 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-31 Financial System Design: Summary of Four Countries (Cont.) • Japan (Cont.) – Historically corporate debt markets have been suppressed, further enhancing power of banks – The result is a vast majority of debt financing that comes from the banking system – Unlike Germany, stock market is quite large, however extensive cross ownership masks high degree of concentration of ownership – Adopted laws that separate commercial banking from investment banking, however, this separation has been eroded Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-32 Financial System Design: Summary of Four Countries (Cont.) • United Kingdom – Financial system is very much markets-oriented, although banks play a very important role – London serves as both a domestic financial center as well as the center of the Eurobond market – Regulatory environment encourages foreign participation and competition in financial markets Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-33 Financial System Design: Summary of Four Countries (Cont.) • United Kingdom (Cont.) – Organization of the banking system • Clearing banks—universal banks, securities activities through subsidiaries, extensive branch networks • Merchant banks—provide wholesale banking services to large corporations • “other” British banks—consisting of institutions similar to merchant banks and specialized banks • “other” deposit-taking institutions—mostly building societies which are similar to savings and loan associations in U.S. 12 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-34 Financial System Design: Summary of Four Countries (Cont.) • United Kingdom (Cont.) – Banks in the United Kingdom generally do not own nonfinancial corporations • While not explicitly prohibited, this practice is discourage by The Bank of England to promote a safer banking system – The Bank of England supervises banks on an informal basis, relying on the English tradition—“Old boy network” and applying moral suasion to influence the banking system Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-35 Financial System Design: Summary of Four Countries (Cont.) • United States – Financial system in the United States has been extensively examined in Chapters 11-15 – Very large stock, bond, and commercial paper markets-- model of the markets-oriented system – Securitization of residential mortgages and other financial assets has further strengthened the traded securities markets – Banks play a key role in external financing for small and midsize companies, not for large firms Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-36 Financial System Design and Conflict Resolution • Measure differences between banking-oriented and markets-oriented systems – Figure 16.3 shows the size of the banking market and stock market in each of the four countries – Banking dominates in Germany and Japan, while financial markets dominate in the U.K. and U.S. – Large degree of ownership by banks in banking-oriented system, much less in markets-oriented – Quantitative evidence strongly supports labeling Germany and Japan as banking-oriented and the U.S. and U.K. as markets-oriented 13 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-37 FIGURE 16.3 Size of banking and stock markets (percentage of GDP), 2007. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-38 Financial System Design and Conflict Resolution (Cont.) • Conflict Resolution in the Big Four – How is financial distress managed within the two major orientations of the financial system – When a company is in financial distress it cannot meet its financial obligations • For markets-oriented system, during these periods, stockholder- bondholder (lender) conflict is extreme since owners have very little stake left in their firm and cannot agree on a strategy short of bankruptcy • In banking-oriented systems it is easier for company to deal with conflict under protective wing of its main bank. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-39 Financial System Design and Conflict Resolution (Cont.) • Conflict Resolution in the Big Four (Cont.) – Dealing with manager-stockholder conflict varies between the two systems • Concentration of ownership in the banking-oriented system gives banks a major incentive to monitor corporate management • Due to diffusion of concentration in the markets-oriented system, little incentive for the individual stockholder to monitor performance • Predictably, there is a much larger volume of mergers and acquisitions under the markets-oriented system 14 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-40 Financial System Design and Conflict Resolution (Cont.) • And the Winner is. . . – Each system has advantages and disadvantages – A few conclusions: • Banks with substantial ownership are better at solving the stockholder-lender or management-stockholder conflict than rating agencies or individual stockholders • This requires intensive monitoring which is expensive • Stocks and bonds issued by firms in banking-oriented systems are much less liquid because of poorly developed markets Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-41 Financial System Design and Conflict Resolution (Cont.) • And the Winner is. . . (Cont.) – A few conclusions: • This raises the cost of raising capital in Germany and Japan • Therefore, there is a trade-off between the two systems – Financial innovations and developments in all four countries suggest that there might be a good compromise between extremes of the two systems Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-42 Financial System Design for Eastern Europe and other Emerging Economics • An initial development in these countries was to develop privatization programs which transforms government-owned companies into privately owned firms • Typically involve distribution of shares to major stockholders (employees, managers, and creditors) • Privatization initially focused on small and midsize companies 15 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-43 Financial System Design for Eastern Europe and other Emerging Economics (Cont.) • Privatization must occur with developments of new securities markets—primarily equity markets • However, it is likely a banking-oriented system may make more sense for these formerly planned economies that are accustomed to strict governmental control Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-44 Financial System Design for Eastern Europe and other Emerging Economics (Cont.) • At present, Eastern Europe can be regarded as an information-poor environment, with little public information about large firms – Rating agencies do not exist – Reputation building is extremely difficult – Lack of managerial talent and experience suggests that monitoring will be especially critical • All these factors indicate that a banking- oriented system may be more suitable Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-45 TABLE 16.1 Estimated Ownership Patterns (percentage) 16 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 16-46 TABLE 16.2 Merger and Acquisition Activity: 2002