Market-based Financing Model Study

Economists have constructed a vast number of theoretical and empirical insights into the comparative advantages of different financial systems. This paper assesses competing theoretical views on whether bank-based or market-based financial systems are better for promoting long-run economic growth. The debate on the comparative merits of bank-based and market-based financial systems has centered on Germany and Japan as bank-based systems and the United States and the United Kingdom as market-based systems. Nonetheless, it is difficult to draw broad conclusions about the long-run growth effects of bank-based and market-based financial systems based on only four countries because they have very similar long-run growth rates since the Second World War.Markets as well as banks perform vital functions in an economy, which include capital formation, facilitation of risk sharing, information production and monitoring. The case for bank-based or market-oriented systems could be made based on the relative effectiveness with which banks or markets execute these common functions. I believe that banks and markets are complementary in providing financial services and financial system architecture matters in that markets or banks may have a comparative advantage in delivering particular services depending on the economic and institutional environments of the country. The Efficient Market Hypothesis is the theoretical basis for market-based financial system to work well. This hypothesis holds that equilibrium prices formed in markets provide valuable information about the prospect of investment opportunities to real decision of firms which, in turn, affect market prices. However, well-developed markets quickly and publicly reveal information, which reduces the incentives for individual investors to acquire information. In liquid markets, investors can inexpensively sell their shares, so that they have fewer incentives to exert rigorous corporate control.Because the stock ownership is much more dispersed in the US than in Germany and Japan, conflict of interests exists between shareholders and management extensively and seriously in the US companies. In the absence of large shareholders and effective insiders control on management, costly hostile takeovers are very common in the US. The introductions of executive stock option, independent directors and cumulative voting provided some ways to mitigate agency problems between investors andmanagement, however, with extremely dispersed ownership structure and less efficient stock market in the US, these ways of external and internal corporate controls are not so effective as expected.Because it takes a much longer time to develop efficient stock markets that to create a sound banking system and in the absence of well-developed stock market, banks are in a better position than any other existing institutions to ensure appropriate monitoring of managers and good corporate governance. This is a useful experience for China to choose its own financial system.