This irrationality is expected to adversely affect the real sector of the

This irrationality is expected to adversely affect

This preview shows page 14 - 17 out of 44 pages.

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
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JBAS Vol. 4 No. 1 June 2012 15 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 investment, managers are not encouraged to undertake long-term investments since their activities are judged by the performance of a company‘s financial assets, which may harm long run prospects of companies. In addition, empirical evidence shows that the takeover mechanism does not perform a disciplinary function and that competitive selection in the market for corporate control takes place much more on the basis of size rather than performance. Therefore, a large inefficient firm has a higher chance of survival than a small relatively efficient firm. These problems are further magnified in developing countries especially sub-Saharan African economies with their weaker regulatory institutions and greater macroeconomic volatility. The higher degree of price volatility on stock markets in developing countries reduces the efficiency of the price signals in allocating investment
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16 Tiruneh Legesse resources. These serious limitations of the stock market have led many analysts to question the importance of the system in promoting economic growth in African countries. Supply and demand prospects for securities market The Ethiopian finance sector is dominated by the commercial banks (private and public) whose focus is on mobilizing short-term liabilities and extending short term loans. These banks have limited capacity and are less reliable to support Project Financing. The banks, expected to extend loans for projects with long-term pay back have limited resources of their own to sustainably support long-term credit supply to the economy. This clearly shows that a securities market is a missing element in the financial structure of the country (Yishak, 2000).
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