Financialisation of business firm

Goal of these companies is maximising shareholder value via dividend disbursement

LAHORE:

A business firm is said to be financialised when it involves in financial activities. In other words, a business firm permanently expands its financial activities. This permanent involvement gives rise to a long-run trend where shareholder value maximation takes the driving seat. Hence, the business firm orients itself for the benefit of shareholders.

When shareholder value maximisation becomes the goal of the business firm, it deviates from the key goal of profit maximisation in production. This change in goalpost alters the structure of the business firm a great deal. In this changed scenario, the business firm intends to maximise return on equity.

Return on equity is increased through dividend disbursement. For the sake of instant gratification of shareholders, the business firm intends to distribute profit among shareholders. This profit disbursement in the form of dividends takes prominence over other requirements. Even the business firm downsizes its labour in order to generate and distribute dividends.

Furthermore, the business firm also buys back its shares from the stock market. The purpose of buyback is to increase return on equity and hence shareholder value maximisation. Even the firm takes loan to buy back its shares – borrowing for the sake of buyback.

The business firm acquires shares of other business firm from the stock market in order to get management control. For instance, a large cement company acquires shares of a relatively smaller company. In the jargon, this is known as merger and acquisition (M&A). This merger and acquisition further increase the market size of the large company which, in turn, increases the return on equity.

Business firms in Pakistan also invest in financial activities. They invest in term deposits to get fixed interest income. Similarly, they also invest in units of mutual funds. In addition, they invest in listed shares at the Pakistan Stock Exchange (PSX) to receive dividend income and capital gains.

Export-oriented business firms in Pakistan buy derivative instruments such as interest rate swaps and currency swaps as they face interest and exchange rate risks and intend to protect themselves against these risks. In addition, they have enough cash and use these instruments for speculating gains.

There are instances where business firms speculated on these instruments and experienced heavy losses and even went bankrupt. This normally happens in a topsy-turvy international financial environment as their speculative bets turn out to be away from expected. However, the listed firms document gains or losses in their financial statements.

A productive business firm operates to fulfil the demand of consumers. It produces goods and services according to the requirements of consumers. If the expected demand is high, it employs people and produces goods and services. This will also increase consumption demand. Hence, a combination of investment and consumption increase the aggregate demand. This increase in aggregate demand increases income/output of the economy.

On the other hand, the business firm will not operate if the expected demand is low, which normally happens in the phase of recession. Since business firms have enormous amount of cash, they invest in financial assets: mutual fund units, treasury bonds, listed equities, term deposits and derivative instruments to get quick returns. The only way they leave investing in financial assets would be the availability of profitable opportunities of real investment.

In a nutshell, financial assets have become a permanent feature of business firms and act as outlets of profitability. These assets generate short-run profitability for shareholders while instability of real investment increases. Since profitable opportunities of real investment are low in a stagnant economy, financial assets rule the roost which give rise to a financialised business firm.

The writer is an independent economist and authored a book: Pakistan's Structural Economic Problems in the era of Financial Globalisation