Macroeconomic effects of financialisation

Shareholder value orientation increases debt, reduces real investment and aggregate demand

LAHORE:

In the era of financial globalisation, most of the business firms follow a shareholder orientation strategy. Shareholder orientation means that business firms intend to show high profitability. They usually show this profitability by downsizing the workforce and then distributing higher profits among shareholders to satisfy them.

This shareholder orientation strategy at the micro level disappoints in terms of profit rate at the macro level. In other words, the financial gains enjoyed by business firms at the micro level cannot be realised at the macro level.

A shareholder-oriented business firm focuses on higher profitability. Their Chief Executive Officers (CEOs) are incentivised through stock options, which means that higher dividend payouts will increase their salary/compensation packages. These CEOs outsource certain functions to minimise their labour force.

They also hire contractual workforce in order to lessen their wage bills. Since these managers have short-term contracts, they intend to increase profitability in order to raise their compensation.

Business firms, which focus on shareholder value orientation, also resort to share buybacks. As these firms do not retain profits, they have to either borrow from banks or issue bonds. Such borrowings increase their corporate debt-to-equity ratio. Hence, these firms become highly leveraged in the course of time and their dependence on debt increases.

A leveraged firm intends to have easy access to credit. Credit access is easier when circumstances are normal. As the circumstances are far from normal, credit access becomes difficult. Under these circumstances, these business firms become financially constrained. Such situations may be a prelude to a firm-creditor conflict.

Business firms are meant to invest in real capital ie, investment in machines, men and materials. The realisation of real investment is uncertain. Shareholder value orientation does not allow business firms to invest in risky ventures.

These firms become selective in their investment projects as they tend to choose less risky projects. This selection of investment projects does not increase aggregate demand, as and when required. Specially, selection and continuation of risky investments are necessary during the phase of recession.

Many business firms listed on the Pakistan Stock Exchange (PSX) have adopted a shareholder orientation strategy. Firms from cement, banking, insurance, textile and pharmaceutical sub-sectors have bought back their shares in the last four years as they held excessive cash in their balance sheets. Few of them have bought their shares twice in the last couple of years.

Similarly, financialised households are involved in debt-financed consumption. These households buy and consume durable and luxury products and services through borrowings. Such borrowings increase the debt-to-income ratio of consumers. If access to credit is easy, consumers will increase their consumption.

In an economy, a small percentage of high-net-worth consumers are bondholders while a large percentage of low-income individuals are consumers. High-net-worth individuals have a low propensity to consume while low-income individuals have a high propensity to consume. Debt-financed consumption transfers income from low-income consumers to high-income ones which, in turn, reduces aggregate demand.

Access to credit entices consumers to increase consumption in the short run. Debt-financed consumption increases the debt burden on consumers. Owing to debt servicing and repayment obligations, consumption decreases in the long run.

In short, shareholder value orientation increases the level of debt in the economy. Moreover, it decreases the level of real investment which, in turn, reduces aggregate demand. The decline in the level of aggregate demand has contractive effects on the macroeconomy. This situation does not bode well for the aspiring millions.

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