The financial markets entail places where investors or traders buy and sell commodities, stocks, foreign exchange, and bonds. Therefore, it is vividly important to understand that the financial markets work. However, financial markets with larger trading activities are known to provide more liquidity to those individuals participating in the market as opposed to thinner markets with less available securities (Hillier, Grinblatt, & Titman, 2011). On a further note, the U.S financial system is ranked as the best and most developed in the world. Similarly, since most financial assets are liquid, some of them have secondary assets that propel the transfer of existing financial assets at low cost. Moreover, sellers can also unload assets easily whenever they there is a need to raise more cash.
Financial markets are critically involved in the accumulation of capital and production of goods and services (Hillier, Grinblatt, & Titman, 2011). Precisely, the markets create an open and controlled system that institutions, firms or organizations can get a large amount of capital to boost their business. They direct the allocation of resources such as credit throughout the economy. Such actions are done by the use of bond and stock markets. Therefore, the existence of a stable financial markets in a country facilitates the international flow of money between nations. Additionally, an economy with an efficient financial market will always reduce its search and transaction cost (Hillier, Grinblatt, & Titman, 2011). A well-developed financial market provides lenders and borrowers with a variety of financial products that match their needs. Also, the financial markets work by allowing investors to offset risk with derivatives, commodities, and foreign exchange contracts.
The role played by the Federal Reserve is still relevant, and precisely, it has done for good than harm to the economy of the country. The Federal Reserve has its primary role of clearing and settling payments transacted between banks. It sums the net obligations a bank incurs to one another and settle the payment by transferring balances from one account to the other. According to the history, it was the function of the private clearing house association to clear and settle inter-banks payments (Hillier, Grinblatt, & Titman, 2011). On a further note, they still handle approximately a half of such an activity. Also, the private systems are used to clear the credit card payments. Since the member banks own the private clearing associations, the Fed’s operations could easily be privatized.
Second, the Fed plays a role of regulating commercial banks. It is the work of the regional Federal Reserve Banks to scrutinize commercial bank’s balance sheets (Hillier, Grinblatt, & Titman, 2011). This will ensure that such banks have sufficient reserves and capital to carry out their daily operations. In the past years, the regional clearing association would ask member banks to disclose their financial statement to determine sound members. However, it is now the work of the Federal Reserve to supervise and regulate financial institutions and protect the credit rights of the customers. Ultimately, the Fed ensures that the economy runs smoothly by conducting monetary policy (Hillier, Grinblatt, & Titman, 2011). It determines the rate of interest that commercial banks should charge on loans. Therefore, it determines the money supply that exist in the economy by influencing the money and credit conditions.
Agency costs referrers to the conflicts that usually arise between managers and shareholders. According to the agency view of a corporation, the managers has the decision rights (Hambrick, Werder, & Zajac, 2008). It is because of their control that they can act in the interest of the shareholders. However, the agency costs arise because of the following. First, they arise because some managers might possess partial control of behavior in the corporation. Second, these costs will arise when individual managers have personal objectives that are quite different with the shareholder’s goals of maximizing profit for the organization. The top executives in an organization are responsible for making decisions; on the other hand, the shareholders legally own shares. Therefore, the shareholders have the right to vote on directors and sell shares. Besides, they usually concede their control to the managers.
In situations when both the shareholders and managers attempt to benefit from the organization, they often enter into a conflict of interest. For example, managers might spend money on an unnecessary project, purchase other firms to expand their territory. Other may engage in self-dealings and benefit themselves over shareholders. The solution to such scenarios is the establishment of current or modern corporate governance. Its primary goal to eliminate conflicts of interest between the shareholders and managers (Hambrick, Werder, & Zajac, 2008). Also, it tries to evaluate the implications of the corporate governance system. Does it hamper or improve the working condition of the organization? Advocates of governance have intervened and encouraged corporations to ensure that shareholders’ rights are respected. Also, they should help them with learning and exercising their rights.
According to lawyers and analysts, the most of Sarbanes-Oxley is working. The Act has strengthened the auditing practices, and it has elevated the accounting industry to a better platform with regards to financial standards. Similarly, it fended off the famous Enron-sized book-cooking disasters. After President Bush had signed the law in the year 2002, Public Company Accounting Oversight Board (PCAOB) was created as a new auditor watchdog (Li, Pincus, & Rego, 2008). The law set stiff penalties to all executive who might engage in fraud or any accounting related crimes. Therefore, it has strengthened and regulated companies’ accounts. One of the provisions of the law is that the executives should certify the accuracy of their financial statements. Those who fail to fulfill the requirements will serve a jail term of up to 20 years (Li, Pincus, & Rego, 2008). In recent cases, quite a good number have faced criminal charges over giving false information in their financial statement.
Moreover, Sarbanes-Oxley law increased some of the criminal penalties. For example, the maximum term to imprison a person for mail fraud was increased from 5 years to 20 years. The changes in the Sarbanes-Oxley law brought a great impact and created a mindset that it will not tolerate any accounting shenanigans. Therefore, they will get much longer sentences than they thought. Also, because of Sarbanes-Oxley, companies’ restatements also changed. Initially, when executives scrambled to correct their past financial reports, the restatements were high and peaked at 1,790. This was in 2006 according to a research firm. However, after the house-cleaning period, it dropped to 790 in the last two years (Li, Pincus, & Rego, 2008).
Hambrick, D. C., Werder, A. V., & Zajac, E. J. (2008). New directions in corporate governance research. Organization Science, 19(3), 381-385.
Hillier, D., Grinblatt, M., & Titman, S. (2011). Financial markets and corporate strategy (No. 2nd Eu). McGraw-Hill.
Li, H., Pincus, M., & Rego, S. O. (2008). Market reaction to events surrounding the Sarbanes‐Oxley Act of 2002 and earnings management. Journal of law and Economics, 51(1), 111-134.
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