market in which funds are transferred from people who have an excess of

Market in which funds are transferred from people who

This preview shows page 10 - 11 out of 19 pages.

market in which funds are transferred from people who have an excess of available funds to people who have a shortage. Financial markets, such as bond and stock markets, are crucial to promoting greater economic efficiency by channeling funds from people who do not have a productive use for them to those who do. Indeed, well-functioning financial markets are a key factor in producing high economic growth, and poorly performing financial markets are one reason that many countries in the world remain desperately poor. Activities in financial markets also have direct effects on personal wealth, the behavior of businesses and consumers, and the cyclical performance of the economy. Critics on financial markets The role of financial markets in economic development continues to attract increasing attention both in academia and among policy-makers. Evidence from recent empirical studies suggests that deeper, broader, and better functioning financial markets can stimulate higher economic growth (Loayza and Beck, 2000). Although evidence on Africa is still limited, the results from existing empirical work supports the view that financial development has a positive effect on economic growth in African countries (Ndikumana, 2000). To the contrary, scholars also stated some arguments against financial markets saying that establishing financial markets is a mixed blessing, rather it has considerable limitations. The first critic is that financial market prices do not accurately reflect the underlying fundamentals when speculative bubbles emerge in the market. In such situations, prices on the financial market are not simply determined by discounting the expected future cash flows. Under this condition, the financial market develops its own speculative growth dynamics, which may be guided by irrational behavior. This irrationality is expected to adversely affect the real sector of the economy. Critics further argue that financial market liquidity may negatively influence corporate governance because very liquid financial market may encourage investor myopia. Since investors can easily sell their securities holdings in more liquid financial markets, their commitment and incentive to exert corporate control may be weaken. In other words, instant financial market liquidity may discourage investors from having long-term commitment with firms whose securities they own and therefore create potential corporate governance problem with serious ramifications for economic growth. Critics also point out that the actual operation of the pricing and takeover mechanism in well-functioning securities markets lead to short term and lower rates of long term investment. It also generates perverse incentives, rewarding managers for their success in financial engineering rather than creating new wealth through organic growth. This is because prices react very quickly to a variety of information influencing expectations on financial markets. Therefore, prices on the securities market tend to be highly volatile and enable profits within short periods. Moreover, because the stock market undervalues long-term
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