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Corporate governance in the financial market is indispensable; by the growth of corporate sectors worldwide, post-90s focused its attention on corporate governance rules and mechanisms incorporated in the Corporation’s management to maintain its business credibility. Financial Market refers to a marketplace where the creation and trading of financial assets, such as shares, debentures, bonds, derivatives, currencies, etc., take place. It plays a crucial role in allocating limited resources to the country’s economy. It acts as an intermediary between the savers and investors by mobilizing funds between them.
The financial market was a growing business, its deregulation and mismanagement weakened the company management: matters relating to market liquidity, investor confidence, insider mismanagement etc. was highly challenged. For example, The Harshad Mehta scam played a crucial role in the Indian financial market, giving a much need framework for proper corporate management to have transparency and accountability. The stock market was booming under Harshad Mehta’s impact during 1991 to 1992, who flourished with huge funds, the origin in magnitude not being known at that time. Later, the Harshad factor created the reason for the market frenzy by manipulating a tremendous amount of funds, and misappropriation took place within the Corporation. Along with some banking institutions, the brokers committed frauds through a new mechanism known as banker’s receipts.
According to some rough estimates, it is found that Rs. 4000 crores that place at the disposal of brokers to play in the stock market, siphoned of these enormous sums of money. These funds were diverted for speculative transactions in the stock market, causing irregularities and frauds. These regularities led to the need for a corporate governance code.
“Corporate governance is the control of management in the best interests of the company, including accountability to shareholders who elect directors and auditors and vote on say on pay. How a company is governed influences rights and relationships among organizational stakeholders, and ultimately how an organization is managed, and whether it succeeds or fails. Companies do not fail: boards do.”
The financial market’s corporate governance framework assumes that a company’s corporate governance is simultaneously determined by a set of various inter-related governance components. While the capital markets play a crucial role in enhancing corporate governance standards, effectiveness and credibility play a prime position with a cause and effect relationship. For example, e.g. when a company’s corporate governance quality is enhanced, both its ability to gain access to finance and its financial performance developed, which eventually leads to financial market development. This framework is primarily based on economic, institutional, and financial approaches to corporate governance.
The financial market is an institution or an arrangement that facilitates financial instruments, including deposits, loans, corporate stocks and bonds, government securities and bonds, and other options that can trade in the market. As defined by economists, a financial market is an institution or an arrangement that facilitates the purchase and sale of goods and services; wherein financial instruments such as financial claims, assets and securities are traded. It either has a specific place or location or does not have any separate physical existence. The exchanges and transactions occur through the stock exchange or other mechanisms such as telephone or other electronic media. The prices for these transactions are investable funds which are paid in interest rate transacted through various mediums.
The financial market’s financial functions include providing:
- Borrowers with funds to enable them to carry out their investment plans.
- Lenders with earning assets accumulate wealth by deploying the assets in productive ventures.
- Liquidity in the market to facilitate the trading of funds.
All such financial market activities help the growth and development of business enterprises that directly impact the country’s economy. One of the financial market’s essential functions is to accelerate an economy’s development is a dynamic and resigning financial market.
Components of financial markets
Primary market deals with securities’ latest issue; in this market, the government or the corporate sector issues securities that change hands from the investors’ shoes. This way, newly issued financial assets are bought and sold. In general, the shares are sold in the primary market.
Secondary market deals with the existing claims that there is no new flow of funds for or instruments in this market. No fresh capital is made available to the producers on account of the secondary market transaction as they only deal in existing securities. It renders essential service to the primary market by providing a ready market for trading in securities; The magnitude of transactions taking place in the secondary market influences the primary market activities. The presence of a secondary market lowers the transactional cost by quickly finding buyers and sellers. It allows dealings between them, which ultimately enhances corporate stocks’ liquidity; this induces investors to own stocks and makes it easier for firms to acquire funds in the primary market.
Money market is a market where short-term instruments that mature in a period are traded; it facilitates short-term financing and assures short-term financial assets liquidity. It meets industry trade and commerce’s working capital requirements, reflecting the changes in interest-rate monetary policy. The availability of the credit money market plays a vital role in economic building and liquidity adjustment.
Capital market, on the other hand, is a market where long-term funds are borrowed and lent. It is otherwise called the securities market, where funds are raised through financial instruments such as shares and bonds. It has a price determination mechanism that ensures optimum allocation of financial resources to the economy’s productive sectors. Their price determination is made through the demand for funds and the supply of funds on stocks’ performance in the capital market. The capital Market plays a vital role in the financial system by promoting savings and industry on essential investments to develop its growth and growth. It accelerates industrial concerns by raising funds and corporate sectors by supplying funds for trading and business.
Debt markets: The market where funds are borrowed and lent is known as a debt market. Arrangements are made so that the borrower agrees to pay the lender the original amount of the loan and a specified amount of interest accumulated over time. Issue of new funds occurs in the primary debt market, and purchase and sale of debt instruments are made in the secondary debt market.
Equity market: It is a market where securities ownership is issued and subscribed through stocks and bonds. It is a method of raising capital by corporate sectors through corporate bonds and stocks, which describes the company’s ownership being sad to outside investors. In, equity market, those subscribed to shares of the Corporation are provided with dividends.
Depository market consists of depository institutions that accept deposits from individuals and firms and use those deposits to participate in the debt market by giving loan or purchasing other debt instruments such as treasury bills etc. It is a type of loan market where one person’s deposited funds are funded to other corporations and institutions at an interest rate paid to the depositor. Some of the significant depository institutions are commercial banks, mutual funds savings, bank credit unions etc.
Non-depository market comprises institutions that do not accept liquid deposits. On the other hand, they carry out various financial market functions, ranging from financial intermediation to selling insurances.
Inter-Relation of Corporate Governance and Financial Market
Cadbury Committee was one of the first and renowned committees formed to deliberate on corporate governance; after a debating period, they formed specific best practice codes to implement corporate governance. They are;
1. Role of the board of directors
2. Role of non-executive directors
3. Appointment, remuneration and performances of the directors
4. Financial reporting and audit
5. Regulation of both insider and outsider dominated system of management.
Corporate governance in financial institutions is weighed at the outset of the financial crisis resulting from various internal and external mismanagement—corporate governance reforms considered necessary in witnessing various corporate scandals or financial concerns. One of the most remarkable financial market collapses was determined by the Enron bankruptcy and similar scandals, which led to a widespread overhaul of the audit profession and board governance, including employee compensation, for corporations in general. The second wave of reforms was determined by the great financial crisis, which mainly involved financial institutions and caused sweeping changes of their corporate governance and compensation practices, in addition to enhancing prudential regulation and crisis management regimes for financial institutions.
The financial market is of great use for a country as it helps in many ways. While critically approaching the relation between the financial market and corporate governance, various functions performed by the financial market need a more comprehensive corporate governance role. The functions of the financial market and the related corporate governance mechanism are discussed below:
The financial market supports investors in putting their savings into more productive use and high-returns, helps companies raise capital, open investment resources in the capital market, and facilitate financial assistance through loans and debentures, which enhance income and gross national production. However, the actions can be fulfilled only when the supporting systems operate efficiently. Institutional functions require stronghold corporate governance for the following actions:
Price determination is one of the financial market’s critical functions; it determines the traded financial assets price through buyers’ and sellers’ interaction. They provide a signal for allocating funds in the economy based on the demand and supply through a mechanism called the price discovery process. It maintains the liquidity of the money market. The market players have an essential duty to fix price and retain the liquidity market; it also should sustain a weel-regulated speculator team and price-trend evaluators to provide proper knowledge of market functions to the people.
Board of Directors
The board of directors and executive management are two essential components of a company’s governance process. Various matters relating to the institutional functions are closely related to the board and management’s governance issues and is included in the board’s duty and responsibility, structure and independence, and the management contract. The board seems to be an essential internal mechanism for resolving the agency problems since it is primarily responsible for recruiting and monitoring the executive management to protect the interests of the shareholders and other stakeholders. The financial market comprising of distinct features of Corporation at all levels is closely related to corporate governance rules and regulations.
The details on financial accounts and audit, transparent board, and committees maintain records and timely submission to the government; all such activities prevent fund misappropriation and mismanagement in the market. The participants’ in the financial market should be provided with adequate genuine information which protects them from fraudulent activities and results in reduced cost of the transaction of financial assets.
Funds mobilization and investor confidence
Obtaining funds from the savers or surplus units such as households, individuals, business firms, public sector units, central government, state government, and local entities are significant functions of the financial market. To boost investment and mobilize the funds, the financial market must enhance its investor confidence through proper corporate governance strategies. Financial markets play a crucial role in arranging funds collected in units to facilitate trade and business. This process can be effectively incorporated only when the market implements an effective corporate governance mechanism.
The financial market acts as a sale mechanism for selling and buying financial assets by investors to offer the benefits of these assets’ marketability and liquidity. The capital flow in the financial market can be facilitated only through well-regulated management. Be it a capital market or debt market, depositary or non-depository market liquidity of it can be expedited when the governance strategies on financial accounting and audit, the interest-rate and dividend policies, the board of directors role investor protection, sustainability in pricing, genuineness in the publication of company data are appropriately propagated.
- Transfer of resources is facilitated through the financial market from lenders to the borrowers serving a real economic purpose. This transferring process requires well-trained executives such as intermediaries, depositary institutions, stakeholders in the debt and equity market.
- The financial market’s pivotal role in contributing to the nation’s development by ensuring unfettered surplus funds flow to deficit units. Such funds ensure productivity and boost economic growth and deployment of investments to various entities that impact national development. Such unfettered funds will be aided through funding from depository market participants like commercial banks, credit unions etc.
- Entrepreneurship enhancements; In the growing business environment, financial markets play an essential role in contributing to people’s entrepreneurial class by making them accessible to necessary financial resources. The equity market also give space for smaller investors; proper corporate governance enhances the same. The financial market’s existence acts as a catalyst for boosting people’s entrepreneurship goals. It allows lenders to earn interest or dividends on their surplus investable funds, thus enhancing an individual’s economic standard and national income.
- Industrial development. A nation’s growth and development are measured using its industrial development, concerning its various components of the financial market accelerating industries’ growth. It contributes to the enhancement of the standard of living well-being of the people by creating employment opportunities. The financial market actions can be facilitated only when the internal management is well-regulated through appropriate corporate governance strategies of risk assessment, transparency, accountability, fairness, and equity in managing the company affairs internally and externally.
Linking of corporate governance to the financial market is done through its institutional framework, financial handling, economical building tool etc., particular attention has been focused on the financial market’s corporate governance strategies when a high incident of fraudulent disclosures, funds misappropriation, insider trading, unfair managerial actions etc., represented by the concerns. Some of the well-known incidents are the Enron crisis, the WorldCom and Tyco revelations, as well as other indications of misrepresentation by top management in various giant companies, led to the value of corporate governance code in the financial market, to mitigate the concern that investors may lose confidence in the financial markets collapsing the market liquidity and endangering economic stability which may threaten the viability of such avenues as a source of capital.
One can examine the link between corporate governance and financial markets during the financial crises; in Enron’s case, a revelation of the misrepresentation was accompanied by a loss of market capitalization and a consequent abrasion of about $1 billion in investors’ retirement savings. These kinds of incidences limelight the importance of corporate governance. The inter-relation between the financial market and corporate governance is measured in approaching how management is linked to liquidity, fund mobilization, funding deficit institutions, the board of director’s works, information distribution and the clientele concerns that hold the company stock.
The hypotheses are that both financial market and corporate governance are highly inter-related; instability in company management can cause instability in market liquidity; mismanagement within and outside company can decrease the quality of a company’s management, causing the clientele’s stability to decline. On the other hand, liquidity can also attract more sophisticated agents and improve its governance quality. Thus financial market and corporate governance are strongly related.