Professor of Finance; Alexander M. Knaster Chair;Fellow of the British Academy
Not that we’re through the latest one, but will we see another global financial crisis?
Yes, there will be another one. The only doubt is: have we put in place the financial architecture to minimise its costs?
No, not at the moment. I think there’s a great danger that we’ll revert to carrying on as normal. We do have some voices out there yet to be heard, such as the governor of the Bank of England. The banking experts whom I talk with seem to think that more is being done here than in the States to cope better with the next financial crisis. There’s a better chance of a successful outcome here and maybe in Europe than in the US. We shall see.
There’s an enormous barrier to making structural changes, primarily because banks – and you can’t blame them for this – say, "You impose regulation on us and we’ll move our head offices and some of our activities." They are very mobile. So, it’s going to be politically difficult for the government to make the right structural changes, even if it believes the changes are right. It’s worried that it may impose costs on banks that other countries will not impose, so that banks will just pick up and depart for sunnier regulatory climes. How costly would that be to us? What’s the trade-off between the costs and the benefits? That’s hard. I wouldn’t want to be a politician faced with that question.
Of course. Before the crisis, if you looked at 1,000 empirical papers on corporate finance, what would they have said in the data description? Probably this: our sample excludes banks and financial companies. Why? Because the balance sheets and so forth are opaque; and because, as a colleague said, we really weren’t interested in that area. Banking and finance, or at least the economics of banking, was the province of a small group of professors.Mainstream corporate finance and mainstream financial market research were not very interested in banking.
First of all, we thought there haven’t been a lot of banking crises. You had, say, the savings-and-loan crisis, which, from an academic point of view, wasn’t that interesting. That crisis cost $150 billion, maybe $200 billion; but it didn’t feel like a grand systemic crisis.
Yes, we’ve had a systemic crisis of tremendous proportions. We missed this one – as did so many others, I might add. Now, of course, this systemic crisis will provide work for thousands of academics and PhDs, probably for the next half-century. We’re all interested in banking now – a bit late, though.
All academics and all other disciplines have taken a keen interest in the banking world – down, in many cases, to the man and woman on the street: just look at the impact recently of taxation, public services, public finances, all of that. Previously, if people thought at all about the banking system, it appeared opaque and arcane. It’s not so arcane now; it’s touched their lives. We’d better be more interested in it.
We must see structural changes. I think we should look very carefully at what I call ring-fencing, guaranteeing less of the banking system, so that government — that is, taxpayers — will be less exposed to non-core banking activities. Reduce the volume and value of guarantees that the state makes available to the banking system. That’s something that the governor of the Bank of England has been very insistent about and rightly so. Look at what threatened poor old Ireland: they guaranteed their whole banking system. This is simply unaffordable. Ring-fencing reduces the taxpayers’ exposure. Politically, as I said, it’s not an easy thing to do. It’s very easy to talk about it conceptually and not so easy to apply and implement it.
Surely, and banks are recapitalising and saying, "Look, we’ve raised a lot of equity, our leverage is less, we’re much more aware of risks than we were; things will be just fine now." To that, I say there are very few advantages of being old, but one of them is a long memory. So I remember the banking crisis and property crisis of 1973–1974 and 1991 and again with the recent one, where banks over-lent on property.
You’ve got to ask yourself: why is it that every 15 or 20 years you get these crises? And one answer is that the people who were there at the time have retired and new people have come along and there is no institutional memory. So, will banks rein in their property? Yes. But, in 10 to 15, years will they again be lending a great deal on property? Yes. Will there be another property bubble? Yes. Will that trigger another banking crisis? Yes, unless we make the needed structural changes, because you cannot rely on institutional memory to forestall a future crisis.
Exactly. The fact that you have a very stable financial system today doesn’t mean we won’t have earthquakes tomorrow. As in the recent literal experience of Japan, the fact that we go 10 years or more without an earthquake doesn’t mean that the probability of another has been diminished.
Yes, figuratively. The field of finance was just beginning to adopt, if you like, some rigorous game-changing models. There was Modigliani and Miller (M&M), there was the CAPM (Capital Asset Pricing Model) and what I would call simple economic models being brought into finance. It was a young, I think almost primitive, field. And like anything young, it was boiling with energy and invention; so we had the emergence of efficient markets, portfolio theory, CAPM and the M&M theorems. This was the bubbling, roiling pot that greeted me when I came into academe.
Yes, when I arrived, London Business School had been open only for five or six years. Those were the early and fascinating days.
It was nothing like the school is today. It was a British business school then. Students were mostly British and Commonwealth, with sprinklings of North America and Western European. Today it’s an international business school. Go into a classroom and you can’t tell you’re in Britain; it’s added South American, Eastern European, Asian students and faculty. It has a fantastic array of students and experiences.
Completely. Research in finance has become far more international and is still trending that way. You look at Europe, and finance research is flourishing. You look at banking innovations, and this side of the pond is contributing just as much as the US. You look at stock markets; and you see that those in South America, China, Hong Kong and so forth are increasingly important. You look at capital markets; and see not only Wall Street, but rising markets in India, China, Hong Kong, Russia and, of course, Europe.
I tell my students that what they need to know to make an impact today is far more than it was even a mere 10 years ago. The technical knowledge possessed today by practitioners in regulatory agencies, corporate finance and treasury departments, and commercial and investment banks is far greater than in the last years of the 20th century. So, the bar has been raised considerably for academics like me in trying to influence practitioners. You have to say things that are far more insightful; and that means that students have to learn more, have to be far better trained and have to be more thoughtful than was required years ago.
I’m embarrassed to say that I started reading the Financial Times when I was about 13 years old. I read that pink newspaper, and I really enjoyed reading it. My wife is filled with horror, to this day, that I could misspend my youth in that way. But I was always interested in finance, economics and stock markets. So when I went to business school, I specialised in finance; it seemed the thing to do.
I’ve long been interested in trying to influence research, to publish in the top finance journals and influence research. I have, as well, an interest in the practitioner world. I want my work to be relevant in practice; I want to do work that looks important from the practitioners’ perspective.
One thing is that I give lots of talks to practitioners, overseas as well as in the UK. Another is that I do some advisory work, which helps me to better learn and understand problems I wouldn’t see by only reading academic journals.
It came at first from the Institute of Family Business. I’d recognised that family business was important in some countries; and, when I talked to people at this institute, I saw a direction for my research that was entirely different from what would otherwise have been the case. They were more interested in private companies and less interested in stock markets. They said, "Family businesses are the most common form of private companies. Why aren’t you doing research on that?" My reaction was that the data on family businesses were difficult or impossible to get. They said that, if I wanted their money, I’d better get the data; and I said, "On reflection, I am interested in doing that."
Move to the present day, and what distinguishes my body of work on family businesses is that I’ve looked at the top 1,000 companies in numerous countries, irrespective of whether they’re private or stock market-listed companies.
In the UK, we don’t have strong family businesses on the scale of other countries. And I ask myself, is it because we have thriving capital markets? Is it the very strength of our capital markets that makes families want to sell? Or is there a fundamental weakness in our capital markets, maybe in regulation, maybe elsewhere?
One thing is simply that very little research into family businesses has been done until recently. In the UK, family business hasn’t been an important component of our stock markets over time. I’m also interested in the role of regulation as it impacts family businesses in ways that are different from non-family businesses.
I’m still interested in takeovers; but, more broadly, I’m studying the many other forms of restructuring. I’m interested in distressed restructuring: what happens to distressed or even bankrupt companies. You may be unsure about life after death for humans, but there is most surely life after death for companies. I’m very interested in how underperforming companies are restructured, whether they become distressed or not. I’ve been looking at the efficiency of bankruptcy codes from country to country and also at the efficiency of the banking system in handling distressed companies.
I’m also looking into the intriguing idea of distressed companies choosing the jurisdiction in which they want to restructure. That’s a slight exaggeration, but not a big one. What would happen if companies could choose their jurisdiction and, say, avoid Chapter 11 or the receivership system in the UK or in the German administration system?
The shipping industry, which is a truly fascinating industry in one regard: ships have a very important characteristic that almost no other industry has. They move between nations. And, because they move, when they get into distress, it’s not easy to apply bankruptcy codes to them. What codes apply to a ship that’s moving around the world? If you’re a creditor and going after a ship that’s in Gibraltar, you just have to fax the shipping master in Gibraltar and say, ―Arrest that ship. Then, providing the master is convinced that the loan is owed and there’s default, that ship can be auctioned off under Gibraltar’s maritime law. Where is Chapter 11? Nowhere to be seen. So the shipping industry is one in which jurisdictions can be chosen. And it’s worth examining, because we hope to learn whether jurisdiction of choice is costly or not costly, efficient or inefficient.
Yes, we’re looking at North America, Asia and Europe — trying to understand the extent and degree of activism in each. And it differs among Japan, South Korea, France, the UK and others.
Believe it or not, shareholder activism is present in Japan and in South Korea. In fact, Japan is quite a hotbed of shareholder activism. And its differences from the UK or Europe are remarkable. In Japan, an activist announces a stake in an underperforming company and the share price goes up more than it does in the UK or the US. But then, when you look down the road to see how the company responded, the incidence of response is so much less in Japan than here. It’s a matter of expectations dashed in Japan, rather than expectations fulfilled as in the US and UK.
It seems that one characteristic that transcends most of your many areas of research is comparative examination.
I’m very interested in comparative studies. Why are we different from Germany? Why is Asia different from us? Are we evolving and all going in the same direction in some Darwinian sense? Or are we going to continue to evolve in different directions? What will the global landscape of ownership look like in 20 years? Will Europe and Asia converge around our ownership system or not? Will our capital markets evolve in the same way? Ten years ago, I thought we were going to all evolve in the same direction. I’m much less convinced of that today.
Yes. Finance and banking are surely becoming global, but we’re still looking at more and different landscapes of ownership in a great many countries than exist in the UK and to some extent in the US. So you have to ask yourself, what are the implications of these different ownership structures in terms of, say, corporate governance, regulation or company performance?
I’ve learned that you can’t succeed just by correcting past mistakes. You’ve also got to correct future mistakes, which you don’t even know about, because corrections now mean those mistakes will never be made. That’s why I say there will be another banking crisis, because I’m not at all confident that we’ll identify and implement the financial architecture to address a new banking crisis, one that (most probably) will not replicate any past crisis. What people predictably say in response to ideas for more comprehensive restructuring is, ―Wait, we haven’t had the problem you’re addressing! So your proposed changes aren’t necessary.‖
I’ve also learned to always look to the real world to identify fundamental traits. You can theorise as much as you like; but the real world is much richer, much more complex and much more fascinating.
And finally, I’ve learned not to rely too much on my own judgement, to realise that I might be wrong and the world might be different from the way I think it is. And I’ve come to that conclusion because I’ve been wrong so often. But that’s how one gains wisdom.
This article was taken from Business Strategy Review, for the latest business thinking from all London Business School faculty
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