Take-Home Examination

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Take-Home Examination

Question 1

Since its emergence in the early 90s, corporate governance has evolved various concepts, such as Corporate Social Responsibility (CSR) and pushed for the increased participation of shareholders and stakeholders in corporate management. The business concept defines the set of mechanisms firms employ to function when management is separated from ownership. Following the 2008 financial crisis, corporate governance grew popular as a macro-level economic principle. Lapses in corporate governance structures within multinational companies have been cited as the main cause of stock market collapses. Since then, corporate governance has become a national policy issue due to its influence on economic development. The quality of firm-level corporate governance impacts a company’s ability to gain access to capital and its financial performance. The improved financial status results in capital market development and more stable stock markets. While the direction of causality is not always evident, good quality corporate governance eventually pays off by improving corporate financial performance, stock market stability and national economic performance.

            Good corporate governance is connected to lower capital costs, greater operational efficiency and higher equity returns. Privatization prompts firms to turn to public markets to raise capital. A widening pool of empirical evidence highlights that well-governed firms acquire higher market valuations, influencing their access to capital (Claessens and Yurtoglu 17). Improved access translates into larger investments and greater corporate growth. Moreover, the lower cost of capital and enhanced corporate performance make investments more appealing to investors. The immediate result is more growth and the creation of employment. The magnitude of the effect is substantial as firm-level studies indicate good corporate governance enhances stock market valuations (Claessens and Yurtoglu 21). Nonetheless, a firm’s management determines its capital flows and equity.

Good quality corporate management is associated with less volatile stock prices and a minimized risk of a financial crisis. A study on direct ownership during the East Asian financial crisis outlines that more resilient firms had better accounting disclosure practices and higher external ownership concentration (Imran et al. 3416). The study provides evidence that corporate governance influences corporate behaviour during a financial crisis. However, other studies indicate that weak corporate governance is a causal factor for stock volatility. In 2009, Alan Blinder of the U.S Federal Reserve claimed poor corporate governance was the main cause of the credit crisis (Claessens and Yurtoglu 23). The result was an unprecedented debt to equity ratio that crashed most stock markets. It becomes more difficult for the national economy to source cross-border investments with poorly performing markets. Firms influence markets, whereas markets are the stimulus for external financing.

Better performing financial markets develop national reserves by attracting foreign direct investments. According to Ojo and Van Akkeren, when financial information is poorly disclosed and there is a lack of transparency, analysts and investors lack the ability to assess firms or the incentive to invest in the firms (79). There is sufficient empirical evidence to relate good corporate governance with increased transparency and synchronous stock prices. Poor governance will encourage the negative skewing of stock prices, increasing investment risks while lowering stock returns. Contrastingly, good governance stabilizes stock pricing, influencing the suitability of a firm for mergers and acquisitions (Claessens and Yurtoglu 25). The business concept determines the degree of investor protection and the health of the relationship between shareholders and management in a market. Foreign investor portfolios are bigger in countries with better investor protection and healthy stakeholder relations (Ojo and Van Akkeren 80). National economies cannot build on their capital reserves if they cannot attract and secure foreign investments.

A relationship between corporate governance, stock markets and national reserves exists even if the cause and effect are unclear. Literature outlines that good quality governance improves a company’s valuation, enhancing its ability to access capital. The corporations get to make bigger investments, resulting in better returns. The general improvement in corporate-level financial performance, in turn, stabilizes stock markets. The lower cost of capital, higher equity returns and stable stock markets interplay to attract foreign direct investments. The increased flow of external capital improves national economic performance, allowing countries to build on their national reserves. Future studies should assess the impact of CSR, as a dimension of corporate governance, on stock market behaviour and foreign investor portfolios.

Question 2

Almost a decade and a half since the global financial crisis, some economies remain unbalanced while many advanced ones seek ways to ensure robust and sustainable development. In his article, ‘Towards a Macro-Prudential Framework for Financial Supervision and Regulation‘, Borio provides a detailed outlook on two models used to define risk and financial stability. The article’s main argument centres on strengthening the macro-prudential framework over the micro-prudential for better regulatory and supervisory arrangements in economics. Major economic developments, such as market booms and collapses, are taking longer to unfold, yet the window for planning is getting shorter. The article is compelling in its demand for the re-introduction of time as a dimension for assessing risk and financial stability. Although micro-prudential and macro-prudential frameworks need to co-exist in regulatory planning, the failure to consider financial lifecycles is the main reason behind the lack of real analysis in monetary economics.

            Current financial regulatory arrangements reflect an inability to adjust to substantial economic developments. Borio claims that existing prudential frameworks are unclear about whether prudential powers are held by central banks or individual agencies (4). The lapse stems from the differences in theoretical approaches used to define risk. For instance, the micro-prudential framework calibrates regulatory standards based on risks per individual institution, while the macro-prudential perspective considers systemic risk. Policymakers are at liberty to employ either approach despite none providing a holistic understanding of economic developments. The gap makes Borio’s argument for reconciling the micro and macro perspectives more compelling. However, balancing the two frameworks does not shift policy arrangements from responsive to preemptive. Economic assessments based on macro and micro-prudential models will still have different balance sheets for economic booms and recessions.  

            Reconciliation is the wrong approach because the causes of financial instability always precede monetary intervention. Traditional macroeconomic policies are ineffective because it is no longer clear when a financial crisis is occurring (Morbee 1). Recent economic studies highlight that two of the last global recessions had similar characteristics. Foremost, low inflation happened with the occasional banking crisis (Borio 1). Low and stable economic booms ushered in the Great Depression. Secondly, securitization in capital-intensive markets caused havoc at the micro-level. Regulatory arrangements based on incomplete risk assessments did not halt banks from increasing credit access to private investors. Thirdly, prudential frameworks failed to identify that protracted booms come before a depression in both depressions. Financial instability always occurred before government intervention through monetary policies. Borio’s need for reconciliation highlights a cyclical aspect of global financial instability.

The re-introduction of the time dimension in the macro-prudential perspective will offer regulators a more holistic understanding of risk. According to Morbee, Boom’s macro-prudential framework needs to integrate a financial cycle to improve its capture of global imbalances (1). Economists need to access economic booms characterized by excessive saving and surplus financing every few years. The cyclic assessments will indicate when imbalances are reaching breaking point. At this point, regulatory arrangements employ monetary responses to constrain the economic boom. The policies seek to repair balance sheets before the impending economic burst (Morbee 1). Without considering the time or cyclical factor, regulatory arrangements will lack the incentive to tighten policies during an economic boom. Moreover, the is an increased incentive to loosen the policies during a burst. Identifying when an economy is reaching the peak of an economic surge is key to policy having sufficient ammunition to counter financial instability.

Monetary policies are falling short because macro and micro-prudential frameworks provide incomplete pictures of financial instability. Borio advocates for further developing the macro-prudential framework to reduce the knowledge gap between it and micro-prudential models. While the approach improves the assessment of financial risks, it does not make regulatory arrangements pre-emptive. Economics needs policies that are not macro or micro but rather medium. Therefore, the re-introduction of the time/cyclic dimension in the macro-prudential framework will improve the effectiveness of monetary policies. The assessment approach will facilitate the constraining of economic booms as they near their peak to prevent market collapses. While financial instabilities are inevitable, a cyclic approach provides a strong start to market resilience and recovery.

Question 3

Owning a home in Hong Kong seems impossible for many youth residing in the metropolis. Rising house and rental prices, coupled with a lack of affordable alternatives, are commonly blamed for the housing crisis. However, recent economic research into Hong Kong’s legal traditions provides overwhelming evidence of policy gaps in the city’s real estate economy. Hong Kong embodies a laissez-faire economy where the government controls land supply. The government’s tax laws promote property speculation, which drives up land prices. Insufficiencies in legislative control impact corporate governance in the real estate sector. The regulatory gap promotes the establishment of a monopolized market. The metropolis has weak mechanisms to enable regulatory control. Although Hong Kong’s real estate market is anticipated to grow, it is not a good investment opportunity for the public because it is constrained by poor corporate governance, unrealistic public policy, lack of transparency and weak mechanisms for regulatory control.

            Hong Kong has unsound public policies for property ownership. According to Berry, Hong Kong follows a De Facto high land price policy, which allows the government to reap huge rents from land sales (1). The policy locks out small and medium property owners from the real estate market. In June 1997, Hong Kong’s Basic Law ensured that a capitalistic way of life would dominate society for over five decades. The law states that leasehold is provided under a land auction and tender (Berry 1). Property owners take advantage of the law to increase property value. The Basic Law also states Hong Kong will continue with a low tax policy for property ownership. The non-progressive statute does not prevent the elite’s accumulation of land and power at the expense of the public. As long as land sales remain a lucrative source of government revenue, Hong Kong will see a continuity in unsound public policies.

            Hong Kong’s legal infrastructure allows lapses in corporate governance in the real estate sector, which helps maintain a monopolistic market. Foremost, Hong Kong’s ‘Companies Ordinance and Securities and Futures Ordinance‘ laws do not provide a legal framework for regulating corporate governance (Berry 1). The gap introduces risks associated with asset quality in the real estate market. Secondly, public investors cannot rely on Hong Kong’s accounting standards to assess asset quality because they are not codified to international standards (Forest and Xian 7). Financing institutions do not use balance sheets when disbursing loans because real property is used as security. Thirdly, the financing method fosters a monopolized market (Wong 1). Loan acquisition criteria lock out small and medium property owners from accessing land loans because of the high collateral costs. Only huge corporations can access financing to develop large-scale housing projects.

            Weak mechanisms impede the effective regulation of Hong Kong’s real estate market. The lack of a regulatory framework results in the inadequate enforcement of prudential rules. For instance, literature outlines instances where banking institutes lend up to 90% of property value in the form of mortgages despite Hong Kong’s monetary authority issuing a 70% value ceiling for real estate loans (Berry 1). Poor regulatory control is often associated with inadequate risk management. Assessments of asset quality depend mostly on non-statutory guidelines, allowing for independent actors to drive up property prices and sectorial lending. Therefore, the real estate market becomes a high-risk market for small and medium investors due to the possibility of property and equity fluctuation. Moreover, under Banking Ordinance law, financiers can demand up to 25% interest for land within the city. (Berry 1). Hong Kong’s laws do not prevent monopolistic property investment companies, including banks, from controlling market conditions in the real estate sector.

            Hong Kong’s property market is still haunted by archaic legal traditions bent on maintaining a status quo. Due to unjust public policies, the public is mainly locked out of investing in the city’s real estate market. The government’s heavy reliance on the sector for national growth discourages it from properly regulating housing. Instead, weak regulatory mechanisms, unsound public policy and poor corporate governance characterize the market. Hong Kong desperately needs legal reforms, specifically to civil law traditions. The government is responsible for the housing problem because it shies away from dismantling the status quo established by British colonial rule due to national interests. If the trend remains unchanged, many young Hong Kong residents will carry a bleak picture of the city’s future. In many societies, housing problems underlie deeper social problems.

Works Cited

Berry, F. Asset Quality in HKSAR’s Real Estate Market: A Public Policy and Legal Analysis. University of Hong Kong, 2022.

Borio, Claudio. ‘On Time, Stocks and Flows: Understanding Global Macroeconomic Challenges.’ British International School of Washington, 12 Oct. 2013, https://www.bis.org/speeches/sp121109a.htm, Accessed 31 January 2022.

Borio, Claudio. ‘Towards a Macro-Prudential Framework for Financial Supervision and Regulation.’ BIS Working Papers, no. 128, 2003, pp. 1-26.

Claessens, Stijin and Burcin Yurtoglu. Corporate Governance and Development: An Update. International Finance Corporation, 2012.

Forest, Ray and Shi Xian. ‘Accommodating Discontent: Youth, Conflict and the Housing Question in Hong Kong.’ Housing Studies, vol. 33, no. 1, 2018, pp. 1-17. https://doi.org/10.1080/02673037.2017.1342775

Imran, Zulfiqar, Abdullah Ejaz, Cristi Spulbar and Ramona Birau. “Measuring the Impact of Governance Quality on Stock Market Performance in Developed Countries.” Economic Research Journal, vol. 33, no. 1, 2020, pp. 3406-3426. https://doi.org/10.1080/1331677X.2020.1774789

Morbee, Katrien. ‘The Role of Corporate Governance in a Macro-Prudential Framework.’ The University of Chicago Law Review, 7 Jan. 2020, https://lawreviewblog.uchicago.edu/2020/01/07/the-role-of-corporate-governance-in-a-macroprudential-framework-by-katrien-morbee/, Accessed 31 January 2022.

Ojo, Marianne and Jeanette Van Akkeren. Value Relevance of Accounting Information in Capital Markets. IGI Global, 2016.

Wong, Richard. ‘Different Legal Traditions on Mainland and Hong Kong Lead to Different Approaches to Economic and Social Problems’. South China Morning Post, 8 Dec. 2015, https://www.scmp.com/business/article/1888281/different-legal-traditions-mainland-and-hong-kong-lead-different-approaches, Accessed 31 January 2022.

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