A Discussion Of Banks Controlling Major Equity

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A Discussion Of Banks Controlling Major Equity In Large Industrial Companies Essay, Research Paper The question touches to two important and obviously interrelated issues, that of the need and form of corporate control and that of the role of the financial system in resource allocation. During the last two decades the Modigliani – Miller proposition which stated that there is no relationship between corporate capital structure and the real performance of firms, has been increasingly disputed as the importance and power of financial institutions is realised. In general, a distinction is drawn between “market” and “bank” oriented financial systems, which are thought to correspond to the financial arrangements of the US and UK on the one hand, and of Germany, Japan and

to some extent France on the other. The former are said to rely much more on the equity and stock markets for company finance and corporate control with banks having relatively little direct links with industry and providing relatively little finance. In the Japanese/German “system”, on the other hand, banks have much closer ties with firms, often hold significant equity positions in these companies, are represented in the board of directors and consequently provide a greater proportion of company finance. The superior performance of the Japanese and German industry to that of the Anglo-Saxon countries is often thought to indicate that the former have a “superior” financial system. We should bear in mind, however, that the distinctions are not always as clear. Japan, has

also a large stock market and the equity holdings of financial institutions are high in Britain too, although the equity holdings of institutions in UK are concentrated in pension funds and life insurance firms rather than banks, though the exact significance of that is not clear. Also, we must be aware of the ever present data problems, especially when making international comparisons. A recent study has found that, in fact, bank loans form a greater proportion of investment finance for British firms than German firms. Another point that has to be made is that the apparently “superior” performance of the “bank-based” economies need not be an outcome of the financial system as obviously many more factors are at work here. Even more significantly the causation may run the

other way round since high growth would probably require high investment rates and hence high gearing ratios. Mayer, however, replied that the electronics industry in the UK and US which also experienced quite high growth and high investment, in fact, has an even lower proportion of external finance. Nevertheless, the view that banks are willing to lend more if only the firms asked them to, is quite popular and it implicitly puts the blame for the unimpressive British performance on the managers and corporations. Other findings that stock market financed investment is more profitable to debt financed one, with internally financed projects being the less profitable of all, could be interpreted to imply that it is indeed the managers’ rather than the financial sector’s fault,

who prefer internal capital so as to avoid control and be slack; alternatively it could be interpreted that the financial sector is uninterested in industry, except in cases where the returns are truly exceptional. The essay question asks about banks owning equity in industrial corporations but this does not seem to be a crucial feature in the interactions of the financial system with corporate performance. The distinction between equity holdings and bank loans is increasingly blurred given the process of securisation in the last 2 decades. The two elements which are probably the most important are first, the extent of monitoring banks do over the firms they have relations with, i.e. whether they follow a “hands-on” approach or are passive to management decisions, and second,