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“Korean Stock Exchange 1998”
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PART 3: These questions pertain to the case on “Korean Stock Exchange 1998”. QUESTIONS: 1. What are the merits and demerits of a stock versus a bank system of financing? The question can be answered by discussing the differences between a financial system based on relationships versus one based on arms-length transactions. A relationship based financial system is characterized by a close relationship between a bank and a company and has the comparative advantage of allowing a long-term investment perspective. Because of the close relationship, the bank can be relatively assured that it will be chosen to provide all of a company's current and future financing needs. Therefore, more emphasis is placed on all the business the relationship will produce rather than the merits of a particular project at a particular time. It allows banks to "internalize joint surplus" which means they can afford short-term losses by offering lower rates when a company may be financially weak and then make up for it in the long-run by offering above market rates when the company's ability to repay has increased. This type of financial system occurs when there is a concentrated need and also allows the government greater influence on targeting industries for economic development. It is also occurs when the companies needing financing have fixed capital that they can use for collateral. Finally, it allows companies to "overcome underdeveloped product, labor and financial markets." The main drawbacks of this type of system is the misallocation of resources and lack of price signals. There is a shift of focus from profitability to growth and expansion. This may be done for political reasons to save or create jobs, but it prevents the "creative destruction" necessary for a economy to develop. For example, take two companies, one that is profitable and one that is losing money. In a developed capital market, the money loser would be shut down. However, in a relationship based economy, resources may be diverted from the profitable company to subsidize the money loser to save jobs and prevent social instability.
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