Financialization of corporate behaviour

The global scenario has restated the menace of deep depressions among the economic challenges. Indeed, in the current setting, the principles of corporate behaviour have reinforced the lack of commitment to long-run social and economic sustainability.

Looking backward, in the context of the 1930 Great Depression, John Maynard Keynes pointed out that the evolution of capital markets increases the risk of speculation and instability since these markets are mostly based upon conventions whose precariousness affects the rhythm of investment and employment. Keynes called attention to the fact that the capitalist system has endogenous mechanisms capable of destabilizing the levels of spending, income and employment. He suggested a reconsideration of the understanding of the relations among individuals, society and governments within the market where institutions and conventions could shape human behaviour. Aware of the need to overcome the concept of rationality that overwhelms the homo oeconomicus, his contribution enhances a more extended understanding of the entrepreneurs’ and investors’ behaviour, as well as of their strategies and decisions.

Following these ideas, the Keynesian approach to business dynamics enhanced a more fruitful apprehension of the real-world where the outcomes of the entrepreneurs’ and investor’s decisions are not submitted to stochastic behaviour, that is to say, they are not predictable. Indeed, the process of decision making is based on conventions. As uncertainty is present in all decisions, Keynes relied on the concepts of credibility and degree of confidence on a conventional judgment that is historically built within the markets. In a specific historical setting, the average opinion on future scenarios shapes a convention based on a precarious set of expectations about the behaviour of aggregate demand (consumption, investment, net exports, for example). The degree of confidence on this convention could affect the expected return on investment- the so called marginal efficiency of capital. He explained that the incentive for long-run expanding productive capacity is highly dependent on the state of confidence about the business environment. In his view, the trust in conventions has a social nature and impacts the path of entrepreneurial development. In Keynes’s view, trust is a conventional concept related to the level of confidence in the business environment, that is to say, in the legal, regulatory, macroeconomic and political setting that shape the evolution of the markets.

As a matter of fact, the environment of business changes and new elements might arise that affect investment decisions under conditions of uncertainty. In General Theory, chapter 12, Keynes focused the analysis on the long-term expectations associated. In his own words:
The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak. The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms. In particular it has not been made clear that its relevance to economic problems comes in through its important influence on the schedule of the marginal efficiency of capital. There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule” (Keynes, General Theory, 12, II).

As Keynes warned, the influence of capital markets reinforces the conflicts between business strategies that favour short-run profits, on one side, and those strategies that favour long-run  investment decisions, on the other.  This idea is extremely important today, since the global reorganization of markets has been overwhelmed by the financial logic of investment. Within this framework, the corporations’ strategies have turned out to focus on short-term profits and the distribution of dividends to shareholders, that is to say, to investors.

Over the last two decades, the leveraged buyout business model of private equity firms, as the main agent for mergers, has fed a broader process of increased financialization of corporate behaviour. It is relevant to apprehend this recent business trend since private equity firms have been responsible for the employment standards of tens of millions of workers worldwide. While private equity firms have become important in many economic sectors, the experience of workers and trade unions arises deep concerns because of job losses, reduction in payment conditions and entitlements (including retirement incomes), besides the displacement of business and persons.

Recalling Minskly, in contemporary capitalism,  corporate behaviour and business instability need to be analysed in a framework where the role of finance is outstanding. Corporate behaviour has been increasingly subordinated to financial commitments and, therefore, finance determines the pace of investment and employment.

 

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2 comments
  1. jlegge said:

    The “marginal efficiency of capital” is one of the least useful neoclassical concepts retained by Keynes. Entrepreneurs and corporate investment committees wouldn’t recognise it if it bit them on the bum. Setting that aside, an investment decision will be affected by the apparent value of an opportunity (substantial, not “marginal”) and the degree of uncertainty, both about the opportunity and the general environment.

    Unless one is a Chicago School economist, Keynes’s concept of fundamental uncertainty is self-evident. In a world seething with positive feedback, tiny events lead to massive, and totally unexpected, changes. That said, we can only avoid paralysis by assuming that there is some continuity between past and future. Dixit’s approach to investment under uncertainty appeals to me in both my oldest has as a corporate planning executive and wearing a somewhat newer one mas a management educator. Pragmatically, Dixit’s formulae go close to reproducing corporate investment processes even if Keynesian purists see the geometric random walk as a poor substitute for “real” uncertainty.

  2. I agree wholly with your conclusion, “…the global reorganization of markets has been overwhelmed by the financial logic of investment.” I’ve analyzed this topic for dozens of clients. I’d very much like to hear your perspective on the “why and how” of this overwhelming change.

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