Today, we consider financial intermediation, corporate governance and shareholder protection. Generally, financial intermediaries act as brokers to disparate net spenders and savers. The former want to spend money they don’t have, the latter group possess money they don’t want to spend.
For society’s economic health, if the spender proposes to develop legitimate productive activity to market a product or service at a profit, this behaviour is encouraged. The fact that great ideas seldom originate with the wealthy requires no exceptional insight. Representing such a small proportion of global populations ensures probabilities are small. The history of discovery, invention, genius, and so forth, often feeding through entrepreneurs finding funding to develop great ideas, confirm this insight.
A technology doesn’t exist until idea, intuition, or validated theoretical process is converted into a working model or prototype. Innovation requires entrepreneurship (the two not necessarily merged) which typically relies on venture capital and/or financial intermediaries.
Let’s say we’re considering a brewery, a cement plant, a facility for manufacturing medicinal or recreational marijuana (ganja) for export to the 23 American states allowing its use, or its extracts to produce eye drops as treatment for glaucoma, or a facility to produce extracts from guinea hen weed to combat arthritis and other ailments. Such ventures involve varying degrees of risk.
Financial intermediaries. It is risk –– opaque crater of the unknown –– that modern financial intermediaries help to shrink. In the Caribbean these include banks, insurance companies, building societies, credit unions, investment houses of varying kinds and a capital market exemplified by the stock exchange. Financial intermediaries offer a repository for savers/investors to park their funds at little risk for a small return –– the interest rate.
Having bundled these funds, intermediaries seek borrowers whom they assess according to risks they quantify. They seek “prime customers” –– potential clients with existing collateral assets, good character and credit worthiness. They profit from the difference between lending and savings and other funds rates.
Compared to the stock market such funds are expensive. Why? These funds originate from sources institutionally “guaranteed” by one measure or another and therefore costly. Also, risk assessment professionals and cooperating systems allied to their trade don’t come cheap. Potentially higher yield from stock ownership is accompanied, “balanced” if you wish,
by risk of loss.
So why do asset holders willingly assume risk? Simple answers: “many are gamblers”; people are greedy, greed is good; humans possess “animal spirits”; humans are animals and like the entire planet’s animal species, we too forage. We forage for command over resources –– in the end, cash.
In this continuous endeavour, capitalist market economy invents mechanisms to mitigate risk. Financial services are the most highly regulated business activity in the free enterprise economy. Usually there’s a wide gap –– huge asymmetry in knowledge, expertise and understanding –– between those publicly offering investment vehicles and the “public” to whom these investments are offered. Legislation, regulation and other active and passive control mechanisms exist to ensure fair play.
Another, perhaps more compelling reason for regulation is the need for integrity of the currency and monetary system. Central banks determine whether individuals are “fit and proper” to hold positions such as CEO of commercial banks which themselves are subject to inspection and must conform to the banking acts of their jurisdictions.
Strong legal requirements and regulatory oversight confront insurance providers. How, you wonder, did CLICO and Antigua’s Stanford Financial collapse in 2009, or Jamaica’s indigenous financial sector in mid-1996 melt down? Though they need explanation, they’re not today’s subject.
Summarily, let’s suggest regulatory failure coupled with hubris and incompetence. Add questionable ethical and fiduciary behaviours, plus, perhaps, corruption and move on to corporate law and financial regulatory oversight attempting to protect shareholders.
Corporate governance and shareholder protection. The 118-year-old Salomon v Salomon & Co Ltd British law lords decision establishes that corporations possess legal personality separate and distinct from their shareholders. Mitt Romney in his 2012 bid for the United States presidency declared to an Iowa heckler: “Corporations are people, my friend.”
Is this a conundrum? Can corporations possess constitutional rights? Credit Suisse and UBS may pay billions in fines to the US Department of Justice, but can’t serve a jail term. Do corporations consciously break the law with premeditated contemplation of fines as line item expenditure in undertaking illegal but immensely profitable business? What’s to stop corporate boards or executives from taking decisions inimical to their shareholders?
Corporate law governs behaviours and relationships among corporate boards, company executives and shareholders. Further, stock exchange-listed public limited liability companies must fulfil additional requirements: for instance lodging annual reports on a timely basis. In creating these, financial reporting must meet international standards emanating from institutions like the Financial Accounting Standards Board (FASB). This is not a government entity but rather a private, non-profit institution with the principal aim of, over time, establishing and improving “generally accepted accounting principles” in the public interest. Its legitimacy and power derives from its being designated by the US Securities and Exchange Commission (SEC) as the organization responsible for setting accounting standards for American public companies.
These mechanisms governing capital markets seek information transparency enabling seamless access to timely, accurate and relevant information about company performance and board behaviour.
The BDIH statement. Weeks after BHL board chairman indicated AmBev had gained control of the company, Banks DIH (BDIH), the Guyanese-based sister company of Barbados’ Banks Brewery, issued a public statement claiming sale of its 6.7 per cent shareholding to SLU could not give AmBev 50 per cent of BHL’s issued shares.
On its face, this statement is difficult to fathom. BDIH claims a 2005 memorandum of understanding between the two companies, acquiring shares in each other, mandated either party contemplating selling its stake to give its sister company first refusal. “Accordingly . . . [the statement continues] . . . BDIH offered the first option to purchase its shares held in BHL to BHL. However the board of directors of BHL determined that it was not interested in repurchasing shares held by BDIH in BHL and had no objection to BDIH selling its shares to SLU Beverages.”
Done deal. Why comment? Did BDIH feel attacked, branded or pilloried as a “bad, unwise, uncaring Caribbean corporate citizen” enabling a takeover defeating a CARICOM entity’s bid? Is there bad blood between the Banks sisters? There’s another interesting issue.
Barbados’ Securities Act of August 2, 2001, referring to “employment of deceptive device, etc.”, Part VII Market Conduct And Regulation, establishes at Section 76: No person shall, directly or indirectly, in connection with the purchase or sale of any security . . . (c) make any untrue statement of a material fact or omit to state a material fact with the intention to mislead”. Was this the focus of BDIH’s concern?
Did minority shareholders lose the chance of greater profit because of imperfect information flow? We may never know.
Next week: Impacts of foreign investment on the host country.
(Wilberne Persaud is an economist.