Comparative analysis of financial systems ----A business firm perspective Tim Earnshaw

1. Comparative analysis of financial systems ----A business firm perspective Tim Earnshaw Fabrizio Galvez Kellie Green Kishore Parhi Sigurdur Petursson Zhufeng Wang

2. Objectives • Identify the major characteristics of two different national financial systems through a comparison of two national financial systems. • We are going to look at UK/USA, and Japan/Germany. These pairings – rather than single-country examples - allow us to show that whilst they are broadly similar examples of the different types of system, they still have their differences. Compare the financial systems of UK and Japan as two major financial system operators • Discuss howthe financial systems have affected firms’ strategies and behaviours. • Consider how they are changing in the early 21st century and what effects such changes are likely to have?

3. Health Warning! • Need to bear in mind that when we talk about the different systems they are generalized characteristics • No single country possesses ALL the characteristics of one system or the other but a country will have more characteristics of one system than the other • We are NOT saying that there is no borrowing in UK/USA and no equity issued in Japan/Germany! • The important distinction is the source of long-term funds.

4. What is a financial system? • Commercial banks --ownership --segmentation --Monitoring and corporate governance roles • Securities markets --Ownership and governance --Transparency of operation --liquidity • The state (the MOF) --Fiscal policy --Tax policy --Regulation of financial system • The Central Bank --Money supply --Interest rate --Banking rules Financial system transforms savings into investments

5. What makes financial systems different • The differing importance of securities and lending markets • The mechanism that establishes prices • The way governments operate in financial markets

6. Types of national financial systems • Capital-market based • Credit-based with prices set by governments • Credit-based with prices set by a few financial institutions with little government intervention

7. Consequences of financial systems • Size/Liquidity of Capital Markets • Nature of relationship you enter into is very different if you have easy exit from it • If no easy exit then influence through voice, if you do then influence through exit • Ownership Concentration • High concentration => providers of capital want to active involvement and ability to voice opinion • Low concentration => providers of capital manage portfolio of holdings, not individual holdings • Bank-Firm Interdependence • a result of the different nature of the relationships in the two systems • Reduces to a dichotomy of whether a firm is insider-dominated or outsider-dominated(arms-length)

8. Influence on firms’ strategy / behaviour Until last slide, it was capital-market / credit-based; now insider / outsider dominated. Need to introduce insider-dominated and outsider-dominated?

9. Influence on firms’ strategy / behaviour • Debt-holders want interest payments, equity holders want dividends/capital growth • Debt-providers entering into long-term relationship want to ensure they receive their money back • You can choose not to pay dividends but you can’t choose not to pay interest • Debt-holders have a lower appetite for risk and mitigate through exercising voice

10. Influence on firms strategy / behaviour • Debt-holders like tangible assets • Debt can be secured against tangible assets that can be liquidated if debt repayments are not met • Goodwill or intangibles don’t provide a great deal of comfort to a debt-holder! • Possibility of hostile takeovers • Liquid secondary equity markets mean this is possible, very difficult where ownership is concentrated and non-equity based

11. Influence on firms strategy / behaviour • Different sources of stakeholder conflict to be managed • In outsider-dominated firms, the conflict is between the firms management and the shareholders • In insider-dominated firms, it is between majority and minority stakeholders

12. Characteristic Extent Ownership Concentration Low Size/Liquidity of Capital Markets High/High Price Setting Market Bank-Firm Interdependence Low Government Influence Low Capital market-based system –US / UK

13. Capital market-based system –US / UK • Ownership concentration • Greater %age of securities held by public • Directors, employees hold small %age • Size of capital market • Large as stocks and bonds are major source of funds • Price-setting • Price of securities set by market systems and stockholders’ expectations

14. Capital market-based system –US / UK • Bank-firm interdependence • Banks are source of short-term funds • Arm’s length relationship • Intermediaries act as portfolio holdings • Venture capitalists help to raise capital in exchange for small share of equity • Government’s role • Act as marginal stabilizers • Governing role; not controlling role • Central Bank focuses on monetary aggregate policies; not allocation of resources

15. Characteristic Extent Ownership Concentration High Size/Liquidity of Capital Markets Low/Low Price Setting Institutions Bank-Firm Interdependence High Government Influence Considerable Credit-based system –Germany/Japan