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Fincancial Systems, functions and Systemic Risks. Lecture 15. General systems of corporate governance. Model 1. Shareholder value Model 2. Stakeholder value. Model for shareholder value. Model for stakeholder value. Priority . Profit before responsibility .
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General systems of corporate governance • Model 1. Shareholdervalue • Model 2. Stakeholdervalue
Model for shareholder value Model for stakeholder value Priority Profit before responsibility Responsibility, then profit View on organisation Instrumental Cooperation, a set of contracts Objective of organisation To serve the interest of the shareholders To serve the interests of all partners involved in the business activity
Measure of success Stock price and dividends Content among all interest groups Largest issue Getting management to act in the interest of the shareholders To balance between various interest groups Execution of corporate control Independent external actors with shares Representation of various interest groups Acting of interest groups Instrument (means) Target and instrument
Utility in society To achieve economic efficiency by focusing on self-interest To achieve economic gains by focusing on cooperation Social respons-ibility Individual matter, not an organisational (firm) issue Both an individual and organisational issue
Financial Systems • Market-based system • Control-oriented system
Sixfunctionsof a financial system • Providingwaysofclearing and settingpaymentstofacilitate the exchangeofgoods, services and assets. • Providing a mechanism for the poolingoffundstoundertakelarge-scaleenterprise or for the subdividingofshares in enterprisestofacilitatediversification. • Providingwaystotransfer economicresourcesthroughtime, acrossgeographic regions, and amongindustries.
MORE FUNCTIONS… • Providingwaystomanageuncertaintyand controlrisk. • Providingprice information thathelpscoordinatedecentralized decision-making in varioussectorsof the economy. • Providingwaystodeal with the incentive problemswhenone party to a financialtransaction has information that the other party does not have, or whenone party is an agent for another.
35 % negative yearsWorst decades:30-, 70- and 00th 65 % positive yearsBest decades:40-, 80- and 90th 2008 worstyearever: -42 %
Systemic risk, focus on negative externalities • Systemic risk is something that is built up before a crash. It signifies the danger of the system-wide contagion of the crisis. • Systemic risk is the very spread of financial fragility and financial distress within the system of finance. • System risk can be defined as negative externalities occurring when one actor takes a risk that causes a further risk for others in the financial system.
Focus on liquidity risk • A demand for central bank money and other liquid and safe investments exceeding supply. • A rapid reduction in the loan volume built up during the boom. • A situation where a borrower has previously been able to borrow without difficulty now can not borrow at all, regardless of condition, a credit crunch, or a collapse of the credit market.
Continuing… • A forced sale of assets when liquidity is tight, which in turn further lowers the price of assets - the bubble burst. • A rapid decrease in the value of bank assets, leading to uncertainty about the value of the bank, bank runs and ultimately to the insolvency and bankruptcy of many banks.
Ex post explanationtosystemic risk • A systemic risk is the risk or probability of a collapse of the entire financial system as opposed to problems in its parts. • The systemic risk is indicated by the different elements in the system moving together, and that the correlation between different assets increases.
Focus on Financialinstability (Minsky) • The financial institutions and the functioning of the market change both as a result of market forces and because of practices and legislation. For this reason, the development of various financial variables will differ over a long phase of expansion in relation to the experience of the average business cycle. • The changes in the financial structure over a long period of growth allows the financial panic which then erupts.
Continuing… • An element in the development of a financially unstable financial system is a marked increase in total assets relative to income and capital. • Disturbances in the financial system are caused both by the system's own characteristics and the errors that people make. Once a strong reaction set in on the financial markets, after a long expansion, the shortcomings of its institutions quickly become apparent.
