2. A comparative analysis of corporate finance systems

3. Abstract This section presents the relative strengths and weaknesses of the three major current corporate finance models: The Anglo-American ModelThe Anglo-American Model The Continental Europe ModelThe Continental Europe Model The Far Eastern ModelThe Far Eastern Model

4. The Anglo-American Model of Corporate Finance Many large, independent publicly-traded firms, relatively small shareholders (1-5% average ownership) External financing relies mostly on public capital markets rather than on financial intermediaries. Banks play no corporate governance role Most external financing is done in the bond market. Equity issues are also popular but tend to be less frequent than bond issues

5. The Anglo-American Model of Corporate Finance Capital markets are very large, liquid, efficient, well regulated Small shareholders' interests are protected by regulations, corporate governance by-laws, and disclosure requirements Strong separation of ownership from control. Corporation are run by qualified professionals who have great operational independence. Very active market for corporate control

6. The Anglo-American Model of Corporate Finance: Advantages Corporations can raise large amounts of external financing and effectively spread the financial risk Since capital markets are transparent, intensively scrutinized and relatively efficient, the cost of resource allocation is minimized.

7. The Anglo-American Model of Corporate Finance: Advantages Corporate control is not inherited but rather attained based on professional credentials. The existence of well developed equity markets allow growth companies (such as tech start-ups) to evolve and prosper The existence of well developed capital markets permits the existence of privately-financed pension systems

8. The Anglo-American Model of Corporate Finance: Disadvantages agency problemSeparation of ownership and control leads to managerial entrenchment, excessive perks consumption, etc. (agency problem) agency costsThe monitoring of managers by stockholders is very costly (agency costs) as long as large institutional investors are barred from taking an active role There is a significant opportunity cost associated with information disclosure

9. The Continental Europe Model of Corporate Finance Many small and medium-sized, privately-held, family-controlled corporations Several large and powerful banks play an important role in external financing and corporate governance There is no separation between commercial and investment banking, and banks are universal financiers Public capital markets are small and have reduced liquidity. Equity issues are relatively rare (however, their importance is growing)

10. The Continental Europe Model of Corporate Finance Little mandated information disclosure and little transparency in corporate finance and corporate governance External financing relies less on formal regulation and legal contracting and more on long-term, informal business relationships Less reliance on professionally-trained managers, and on stock- based managerial compensation Relatively inactive market for takeovers and corporate control

11. The Continental Europe Model of Corporate Finance: Advantages Banks can be very effective corporate monitors and can discipline managers Bank involvement in corporate monitoring leads to more direct, low- cost, transfer of information Banks seem better at handling financial distress Banks are better at multi-year continuous financing

12. The Continental Europe Model of Corporate Finance: Disadvantages Conflict of interest when banks are the creditors and the shareholders of the same firm. High potential for abuse and self-dealing since disclosure requirements are very modest and there is little transparency in corporate financing and corporate governance. Since banks have a monopoly on external financing, the cost of raising capital can be high As information technology evolves, the comparative advantage of financial intermediaries over public capital markets decreases

13. The Far Eastern Model of Corporate Finance The national economy is dominated by a very small number of large and powerful industrial groups (Keiretsu in Japan, and Chaebol in Korea) Each group include large manufacturing, service, distribution, etc companies led and coordinated by a major bank. Group companies own blocs of each-other's shares and there are frequently interlocking directorships The industrial groups dominate their home markets and are the major exporters of that country

14. The Far Eastern Model of Corporate Finance Chaebols are still run by family members or founders Keiretsus are run mostly by professional managers Capital markets have little influence in the corporate finance and corporate governance systems Corporate takeovers are very rare

15. The Far Eastern Model of Corporate Finance: Advantages Industrial groups represent a model of achieving rapid economic growth with little reliance on foreign investment Industrial groups internalize large chunks of the economy and manage coordinated technological systems. Industrial groups also bar foreign competition from entering the domestic market Effective and low cost of debt financing Effective management of small-scale financial distress

16. The Far Eastern Model of Corporate Finance: Disadvantages Cross subsidies create a free-rider problem and rivalries between group companies. Internalization of the economy leads to less competition and higher product prices paid by consumers Industrial groups do not prosper in other countires, i.e., outside Japan or Korea. They only fit one or two cultural models.

17. Conclusions: Which system is the best? What is the objective function to maximize? Each system can only be judged in relation to very narrowly defined criteria There is no all-in-one objective criterion Each corporate finance system is unique in its own way