Money, Financial Intermediation and Governance

Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.

Chapter 15: Corporate Governance

Dino Falaschetti and Michael J. Orlando

Subjects: business and management, corporate governance, economics and finance, corporate governance, financial economics and regulation, money and banking

Extract

INTRODUCTION Asymmetric information constrains the set of mutually beneficial trades that an economy can support. Consider, for example, the firm’s profitmaximization problem, and recall that our most simple model (see Part I) implicitly assumes that acquiring inputs is costless – that is, the act of transacting negligibly consumes resources. But when a firm’s internal resources cannot fund input choices, it must demand capital from financial markets. This demand, in turn, must address constraints from asymmetric information. This asymmetry can emerge from those who might supply financial resources having less information about a firm’s prospects than does the firm itself. In addition, potential suppliers likely have little information about how a firm would, after receiving a financial market’s proceeds, actually employ those funds. Absent organizational features that check such asymmetries, suppliers will rationally forgo investing, even in technically valuable projects. In Chapter 14, we examined how intermediaries can economize on such costs and thus push economies toward the superior levels of performance that more simple treatments of the firm imply. We restricted our attention, however, to how proximate suppliers of financial capital can mitigate information asymmetries. But the axiom of maximizing-behavior applies to all economic actors. Consequently, if suppliers of financial capital want to mitigate information asymmetries, then so should demanders. They do, and recent corporate governance scandals (such as those associated with Adelphia, Enron, Tyco, WorldCom) highlight the important role that acting (or not acting) on this incentive plays in an economy’s performance. Absent productive actions from firms (that...

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