Financialization Essay

7917 Words Jan 21st, 2014 32 Pages
Working Paper No. 525
Financialization: What It Is and Why It Matters* by Thomas I. Palley
The Levy Economics Institute and Economics for Democratic and Open Societies
Washington, D.C.
December 2007

Paper presented at a conference on “Finance-led Capitalism? Macroeconomic Effects of Changes in the Financial Sector,” sponsored by the Hans Boeckler Foundation and held in Berlin,
Germany, October 26–27, 2007. My thanks to conference participants for their valuable suggestions. All errors in the paper are my own. Comments may be sent to mail@thomaspalley.com. The Levy Economics Institute Working Paper Collection presents research in progress by
Levy Institute scholars and conference participants. The purpose of the series is
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II. FINANCIALIZATION AND CONVENTIONAL ECONOMIC THEORY
Conventional economic theory has played an important role promoting financialization.
One area where theory has been especially important is the formulation of the relationship between firms and financial markets in terms of an agency problem (Jensen and Meckling 1976) whereby the challenge is to get the firm’s managers to maximize profits on behalf of shareholders. This representation has had important consequences.
First, the agency approach envisages the solution to the corporate governance problem as one of aligning the interests of managers with those of financial market participants. That has been used to rationalize the explosion in top management compensation and stock option grants, and it has also been used to justify the rise of the takeover movement and private equity investment. Second, the agency approach promotes a legal view whereby the sole purpose of corporations—which are a societal construction—is to maximize shareholder returns within the confines of the law. That has served to restrict the focus of policy discussion to how to give shareholders greater control over managers. Meanwhile, broader questions regarding the purpose of corporations and the interest of other stakeholders have been

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