How Economic Systems Affect Corporate Governance - Essay Example

FINANCIAL OR ECONOMIC SYSTEMS Introduction Existing studies indicate that economic systems practised globally differ depending on the ideologies of the government and a country’s culture. Further, studies agree that the economic status and the business environment of a country is the product of a country’s political and economic ideology. In as much as the western world inclines to a more capitalistic structure that is more relaxed and market-oriented, the eastern side is a mix of controlled and market economies whose blend has been critical in catalysing growth in the region. Theory asserts that the success of an economy and the catapulting of business is further reliant on a region’s financial system. A divide exists in the global business within the context of financial systems as each economic giant strives to catapult its ideology over the others. Of note, however, is the argument that economic and fiscal strategies are country specific in terms of level of growth, such that bank-based financial systems best suit the transitioning economies such as China. The report presents an analysis of how economic systems affect corporate governance with insights from various countries. Economic systems and corporate governance A great diversity exists in both the current 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 (Comelli, 2014). 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. So as 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. All this aim at maximising long-term corporate value based on the perspective of an array of stakeholders (Leijonhufvud, 2012). Nevertheless, it is worth noting that the approaches to enhancing corporate governance differs in relation to a countrys 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. 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 needs 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 individuals choice, and not the states directives. In this system producers and consumers drive the economy. The government institutes no bottlenecks to the consumption and expenditure levels of its citizenry. Further, the market is at liberty to indulge in business, enter contracts or sell their services to the relevant party. Producers make decisions on what services or goods they are willing to offer with the freedom extending to all stakeholders. Such that al the stakeholder make choices on how to utilize their limited resources in order maximize output and profitability (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. 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. Most of the modern economies consist of the features from the synthesis or making of two or more economic frameworks. The public sectors harmoniously work alongside the private sector but may compete for the same limited resources. The mixed economic systems do not block or affect the privates sector from committing profit-seeking. However, due to the monitoring of the profit levels and how fast may categorize the companies that are considered or deemed to go against the public good. The mixed economic systems are usually not laissez-faire systems: the state or government is associated with the planning and the usage of resources, and can sometimes exert some control over certain businesses in the private sector. The Governments might be looking way of redistributing wealth via taxing the private sector or utilising funds from taxes in promoting the social objectivities. Capitalism allows prices being set by demand and supply forces while socialism fixes prices via central planning. The mixed economic systems make it possible for prices in particular sectors to be fluctuated, while stabilizing the other prices, for example as energy (Foreman-Peck & Federico, 1999). The dynamics in the global business environment have been critical to the transitions of most former socialist states. As the competition for market continues 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 state and the public enterprises restructured as businesses organization, and the remodelling of the financial sectors for the creation and facilitation of the movement of private sector capital or the macroeconomic stabilization. The said process has or is been applied in China, and some Third world countries. 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). Japan is an archetypal ‘developmental’ state that possesses the high degree of consensus among major interest groups on the need for making a dynamic national economy that reflects the culture of Japanese society (Radtke and Wiesbron, 2002). At the Second World War, the regime had a rigorous task of guiding the operations of the highly competitive local market economy. Governmental institutions with a high degree of consensus and decision-making pushed for an industrial policy that was not the state-led, instead industrialization agreed among officials and business. The Japanese economic model eventually turned into protectionism, export-orientated industrialization, such that directed savings went into a state-controlled finance sector. Further, the government became involved in the development of new or advanced technologies. Eventually, Japan was transformed from the low-skill and low-value economy into a capital-intensive and high-value economy. 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. 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 and 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. Financial System The financial system is described as the system that enables borrowers and lenders exchange funds; hence on the global perspective. It is the broad system that incorporates all borrowers, lenders and financial institutions within the world economy. There are a number components found in the financial system: For example, financial services, financial markets, banks and other financial institutions. In the global scene, it includes the International Monetary Fund, World Bank and central banks (Berend, 2006) The Japanese-German In Germany and Japan a number of principle shareholders, usually banks, frequently hold a substantial percentage or portion of the total equity. This is a different case in the UK, and U.S. since the stock ownership is more dispersed. The Japanese- German systems have large shareholders, so they have a much secured and strong or decisive control over the companies. The hostile takeovers or leveraged buying-outs exhibit the lack of the internal control over the management, which is familiar in the U.S., does not occur in Japan and Germany. The Japanese-German model implies that larger banks referred to as the "big three" or the "big five" etc., take control of the major parts of the total credits (Berend, 2006). Hence, they are in the position of influencing investment decisions of the non-financial companies. The banking system in China is less concentrated as compared to the U.S., Japan etc., and it is majorly dominated by the "big five" or "big three" banks. In the U.S., 50% of the common stock belongs to individuals; this is way much as compared to Germany and Japan with only 17% and 22% respectively belonging to individuals.Institutions or companies controlling 64% and 73% of the stocks; the German and Japanese banks control 10% and 19% respectively, Table 1 and Table 2. Anglo-American System The second system is 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, as seen in Table 1. Country Internal External Total Bank Loans Equity Short-term, Bonds Germany 70.9 29.1 12.1 0.6 -1.1 Japan 59.9 42.1 50.4 4.6 2.1 The U.S. 85.9 14.1 24.4 1.1 12.0 The UK 102.4 -2.4 7.6 -3.3 0.6 Table 1. The net sources of the non-financial enterprise finances (Hasan & Turan, 2013) The Anglo-American system has a higher share of equity is higher, while the Japanese- German model has got companies that are heavily indebted. The American model is the most competitive one, as compared to the Japanese-German model. The U.S. was significantly hit by the 2008 crises since its model does not reduce risks, as compared to the Japanese-German model; the Japanese-German model reduces instability and bankruptcies ((Hasan & Turan, 2013) Differences in the Financial Systems and 2008 Crisis The significant difference between the security-based and bank-based financial systems is the 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) The U.S. managers envied the Japanese managers since they were able to receive steady finances for projects from the banks and also were able to ignore minority shareholders through non-payment of high dividends in lengthily periods of time. Likewise, the Japanese investors admired the American system on the vast opportunities it provided (Hasan & Turan, 2013). Despite the securities-based systems risk being priced by the market itself, the institution-based systems 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. In order obtain any equity capital; it is not a must for companies to possess equivalent asset bases as their security or to exhibit any history in terms of dividend payments. Hence, the newly emerging industries and enterprises are relying on equity financing and not on debt. 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). The study concluded the differences in market-oriented and bank-oriented countries was reflected by the choice of private, the bank loans, or public financing, bonds and stocks, instead of the leveraged amount. Chinese Transition System China had been in decades of the self-dragged separation from world’s economy; now it is rapidly increasing as one of the biggest global players. In 1949, the Communist Party took power and as from 1953 they implemented industrial plans similar to the Soviet’s economy model. The model failed since China was largely an agricultural economy; hence there was continued mass poverty and famine. In the 1960s and 70s, the failing of policy indicated misallocation of stockpiling, goods, rationing of food and clothes. The state-owned enterprises (the SOEs) did not have effective product management, development, workplace technology and skills. In 1979, an ‘open policy’ was formulated, and it controlled investment and trade strategy inward. The policy was set within the context of ‘four modernisations’, that is, industry, agriculture, science, and education. In the 1980s, there was a gradual decline in the price controls, improved employment rights and emphasized in profit making. China is still a central controlled command economy, with the states role remains in the regulation of business. The state agrees on outward investments; attracting or negotiating inward investments; controlling of banking and the capital investment; industrial; the technology policy; and the selection of forthcoming growth sectors. In post-communist states, inclusive of China, banking remains a primaryr source of capital financing, relative to the securities markets at during transition. The market capitalisation remains low at below 11% of GDP, and the bank credits are above GDP. The Chinese banking seems to be the strongest in economics in transition; from figure 1. Figure 1. Bank credit in terms of % of the GDP for 1990 and 1995. Source, (World Bank, 2010) Country Domestic Banking credit, in 1995, in (% of GDP ) The shares of the top 5 banks in the total banking assets, in 1994, (%) The Herfindahl index China 91 Over 80% Japan 296 40 (1992) 0.063 U.S. 132 24 (1994) 0.2 U.K 126 29(1989) 0.036 Germany 154 58 (1989) 0.088 Table 2. Sizes of the bank credits and the concentration of bank assets. Source, World Bank, 2010 Criticism Opponents of the free market ideals rarely question the fundamental premise of Adam Smith’s invisible hand. Competitive markets have a tendency to allocate resources efficiently, producing quality goods and services at low prices. Instead, most opponents of capitalism hedge focus on economic instableness, market bankruptcies and social justness (Hasan & Turan, 2013, 431). Critics argue that inflationary forces can easily creep. Further, critics of controlled system argue that by artificially maintaining prices at low levels, aggregate demand declines to low levels beyond the level of supply, leading to a reduction in products (Hasan & Turan, 2013, 431). In imposing rent controls that maintain rents below the free-market level, studies show that the price paid by bourgeois to discriminate reduces significantly. Corporate governance suffers when the government determines management practises, production and prices (Leijonhufvud, 2012). Firms are unable to determine the level of credit efficiently and between the available creditors. Conlusions Finding the exact economic system that operates to produce a conducive environment for the proper corporate governance is still a debatable issue. Studies argue that though the free market economy prevails through the “invisible hand,” much of its operations are characteristic of capitalism. 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. 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