Firm Investment, Supervisory Architecture and Markets
Are you looking for a discussion of the relationship of firm size to firm investment? In this article I will explain why I am saying that there is an important relationship between firm size and firm investment risk/reward. As I write this article peer reviewed academic publications are still struggling to understand the exact shape of this relationship. There are many discussions in the business and financial investment communities but still a lot of disagreement as to what the correct model should be.
I believe it is very important for any manager to understand the nature of firm investment and how it relates to his or her own decisions about how to manage money and invest it. I say this because there have been many claims in the last few years by central banks of all sizes as to whether they should intervene in the stock market as part of their efforts to get interest rates back to normal. The most common argument is that such interventions would be economically harmful. The claims typically go like this: “if the central bank increases interest rates, firms will reduce their assets as they will have to pass on the costs to customers”. And that is just wrong.
The arguments about costs and benefits have always existed in politics, and centralised banks have even debated about them in the past. The reality is that if the bank increases rates, it has two main costs: increased transaction costs and lower incentives to invest. The secondary costs associated with this intervention include higher inflation (that is, an increase in real estate prices) and the shift of investment from safe to risky assets (which includes, but is not limited to, stock and bond markets). All of these costs are passed on to the customers of banks by lower firm investment.
However, as part of the package of measures the bank was asked to undertake, it decided to change the way it normally conducts its supervisory activities. Instead of relying on journals and faxes, it decided to put together a Working Paper that would be used to make decisions based on the facts that have been collected through the bank’s activities. This is what we are talking about here. The banks are now compiling working papers based on the Basel II principles. This Working Paper was approved by the Banking Union at its Annual meeting in November last year.
In the Working Paper, the Basel Committee on Banking Supervision proposed that member banks should cooperate more actively and pool their resources in order to increase efficiency and quality. It also said that all supervisory arrangements, including the current one, should be replaced by a new and improved set of rules. This Working Paper provides a road map for future improvement of firm investment and supervisory architecture in the euro area countries. It shows how the supervisory architecture can be designed and built on the basis of international standards and provides for a much more efficient and effective coordination of banking supervision. It also suggests ways to overcome obstacles to effective supervisory architecture.
Supervisory changes can be made without reducing firms’ investment or giving them greater freedom. However, it must be possible for firms to comply with these changes and still meet the requirements of the regulatory bodies. In addition, there has to be a way of reducing market friction and boosting cooperation among financial institutions. Finally, firms must be able to adapt to the new supervisory architecture and not feel that they are being pushed around by supervisory processes that have been imposed on them without their consent.