Lecture 4:

INDUSTRIALISATION AND CORPORATE FINANCE

1. Financing Trade and Industrialisation

2. The Companies Acts of 1860s
3. Futures and Options Trading
4. The Capital Market as a Credit Club for Corporations

1. Financing trade and industrialisation

Legal liability of individuals for their debts

Includes liability for debts of companies owned by individuals.

Problem for ‘inactive’ partners → reduced supply of finance.

(Also ‘principal-agent’ problem in management.)

Financing of merchant capitalists (by other merchant capitalists i.e.,

‘merchant’ banks);

Financing of infrastructure that needs a lot of capital (canals,

railways) needs money from ‘inactive’ owners

– Acts of Parliament/Government charter to set up canal and railway

companies;
Financing of industrial capitalism – production using a lot of capital
equipment.

The French (Utopian) Solution: Saint Simon & Proudhon:

→ Enfantin & Crédit mobilier taking deposits of wealthy &

businessmen to lend to business.

Spread of credit mobilier to Germany, Italy, eventually Japan.

2. Companies Acts of 1860s

Allowed routine establishment of companies with limited liability,

subject to registration of company rules with legal Registrar of
Companies or Commercial Court.

Model followed in Europe, North America, British Empire.

Stocks and Shares

Shares/Common stock, give rights of ownership and right to profit

after payment of interest.

Profit distributed to Shareholders is Dividend

Debenture Stocks give rights to interest before payment of other

interest or dividends (payments to shareholders);
Loan Stocks give right to interest, payable before payment to
shareholders;

Preferred Stock (Preference shares) give right to interest if there is

surplus after payment of interest on other stocks;

Thus:

Operating Profit = Total firm revenue – total costs of production;

Pre-tax Profit = Operating profit – interest costs;

Dividends are paid out of post-tax profits or reserves;

Retained Profits = Post-tax profits – dividends = firm’s saving;

Internal funds – cash and liquid assets in the company (including

reserves);

External funds – capital raised in financial markets or by borrowing.

Kindleberger, Kalecki, Gerschenkron – industrial development

financed internally (access to borrowing limited by own funds):

Hence industrial development needs firms’ savings, not

financial/banking development.
Since 1980s: ‘Financial development’ is key to raising finance for
business.

Six consequences of long-term finance:

1. Markets value financial assets (vs. ‘book value’ in banks’

balance sheets) (assist with ‘price discovery’);
2. For companies: ability of companies to ‘match maturity’ of
investment project; fix financing costs; ‘refinance’ into lower
cost borrowing if interest rates fall;
3. Emergence of long-term debt markets: for stocks and shares
offering liquidity of long-term financial commitment;
4. Emergence of large, long-term financed, corporations
monopoly/finance capital (Hilferding/Veblen) vs. competitive
SMEs with limited capital financing;
5. Changed the nature of financial crisis (from crisis of short-term
borrowing for long-term projects to stock market crashes);
6. …

6. Futures and options trading

Primary, vs. secondary market for stocks & shares.

Value of stocks & shares depends on ‘liquidity’ of market: i.e., how

much credit (buying power) is circulating in market,
i.e., how much credit do individual portfolio owners hold that they are
willing to use to buy financial assets (buyers or ‘bulls’)

vs. how much credit do individual portfolio owners need to take out
of the market (sellers or ‘bears’).

Fluctuating liquidity in markets → variations in prices.

Long-term debts/obligations as ‘security’ for new credit

→ Huge expansion of credit/liquidity in markets.

Huge expansion of scale of price changes in markets for long-term

securities.

Hence:

Financial futures and options.

Providing certain future values for securities in future.

‘Hedging’ values of securities e.g., holding shares with ‘put’ option.

Speculation with futures and options.

4. The Capital Market as a ‘Credit Club’ for Corporations

Emergence of monopoly/finance capital
Hilferding ‘Finance’ Capital around Berlin Clearing Banks
Monopolies use prices and markets to assure stable profit revenues –
SMEs absorb profits and losses of business cycle.
In US ‘Morganisation’ of industry into Trusts holding
controlling shares in smaller producers in given industry
(petroleum, sugar). (Krzywicki)

Today:
‘Over-capitalisation’ of corporations: US Stock market dominated by
large IT corporations (Microsoft, Alphabet, Amazon, Apple)
that employ few workers, little real (productive) capital and in effect
are giant ‘investment trusts’ (buying and selling companies).

New financial cycle (based on stock market)(Veblen).