The Language of Finance

The theory and practice of finance is based upon information (Wilhelm and Downing 2000) that rolls the wheels of global financial transactions. While global finance encompass institutions and flows of traded currencies that lead us to public international institutions. Their aim is to manage financial stability by responding to and coping with the adverse consequences of uncoordinated market action (Cable1999). Other important element brings us to “private” institutions such as institutional investors and the market for financial services that have mushroomed over the past 40 years or so to dominate the management of global financial assets (Davis and Steil 2001). There are communal institutions considered as the building blocs of social practice (Pettit 2002) referred in modern portfolio theory and its related offspring. Clark argues that the language of finance has distinctive market specific characteristics representing its history in the Anglo-American world.

The language of finance revolutionised Anglo-American financial markets, and guides portfolio investment managers as they circle the world looking for investment opportunities. In part, the presumption in favour of portfolio diversification has taken institutional investors to other markets around the world though based upon very different historical circumstances, customs, and conventions (i.e. political economies). One consequence has been the drive to standardise information disclosure in each and every market against various public and private templates, including those developed by the International Accounting Standards Board. Another consequence, however, has been to re-conceptualise the role and status of portfolio investors especially as regards their role in affecting the governance of major corporations (Clark and Hebb 2004).

One way of extracting value from financial market requires a better appreciation of the empirical relationships found between corporate governance and market value (however both are measured and described). This empirical world is inevitably and fundamentally information intensive. But it now goes well beyond the reference points of finance theory that held sway for a couple of generations (for example, Ho and Lee 2004).

The information required to make judgments about those responsibilities has begun to take into account a variety of issues previously excluded including social and environmental concerns. In a sense, the failure of the language of finance has given the market for information a remarkable boost and with it the opportunity to establish new metrics for judging the performance of global corporations over the short-run and the long-run (Clark and Hebb 2005).

Whereas financiers played crucial roles in the formation of conglomerates in the US, Chandler argues that their significance was quickly discounted as the expanding scope and scale of corporate activities empowered managerial elites. He compared US managerial capitalism with other forms of capitalism in developed economies distinguishing, for example, between Britain (personal capitalism) and Germany (co-operative capitalism). Most importantly, he suggested that public distrust of banking over the 19th century and early 20th century was such that the US finance industry remained decentralized, fragmented, and the fiefdom of individuals rather than national institutions (in contrast to Germany and Britain).1

The Keynesian-cum-neoclassical synthesis which was to hold sway in economic textbooks for nearly forty years hardly ever mentioned finance except when discussing the causes and consequences of the 1929 crash and the coordination of international trade. By the early 1980s, however, the financial system and stock markets had become very important in Anglo-American economies: pension funds were growing fast in terms of the volume of net contributions and accumulated assets, and; the deregulation of the banking industry during the 1970s and 1980s combined with recurrent waves of mergers and acquisitions in manufacturing industries prompted the growth of new kinds of financial intermediaries as well as the demand for new kinds of financial products (Allen and Gale 2000).

Over the second half of the 20th century, in the Anglo-American world managerial capitalism was overtaken by financial capitalism. New kinds of national and global institutions were formed with access to financial resources far-surpassing those available to hitherto largely self-financing manufacturing corporations.

Underpinning the emerging power of financial capitalism has been a set of rules, regulations, and practices as well as iconic glass and steel office blocks. For example, Anglo-American pension funds are governed by the principle of fiduciary duty inherited common law of trust albeit formalised in statute and regulation (Clark 2005). Importantly, regulations requiring the full funding of expected obligations against market value combined with a required (if not always enforced) separation between the financial interests of the plan sponsor or sponsors and plan beneficiaries created large pools of “independent” investment capital.

This can be thought instrumental in that academic research is, sometimes, applied to pricing stocks
and modelling market patterns. But we would contend that there is another less instrumental side to the
story. Once we focus upon market institutions and behaviour, there are important conceptual puzzles to
be resolved that go to the heart of social science – such as the predictability of behaviour over time and
space in a global economy (Shiller 2003).

For many years, fiduciaries had been governed by the so-called “constrained” prudent man rule. By this interpretation of trustee responsibility, each and every investment was to be evaluated with respect to expected risk and those investments deemed too “risky” were to be avoided as a matter of principle (Gordon 1987).

If the early years of the 20th century saw the rise of a corporate elite claiming power at the very centre of their organisations, by the end of the 20th century a new elite had been born operating within and without the modern corporation using the tools of finance to claim control of corporate capitalism.

An institutional perspective that is sensitive to history and geography is an important element in any comprehensive treatment of the development of twentieth-century capitalism; a common epistemological commitment shared by those working on comparative corporate governance and the geography of finance (see also Hopt et al. 1998 and Clark and Wójcik 2005a).

One of the most important differences between the finance capitalism of the 21st century and the financiers of the late 19th and early 20th centuries is the fact that finance is now an industry populated by many thousands of skilled employees who share, more often than not, a common language about the theory and practice of finance. Whether located in New York, Tokyo, London or Frankfurt and whether employed by Goldman Sachs, the Bank of Tokyo, or Deutsche Bank, they all know about the capital asset pricing model, the Black-Scholes option-pricing theorem, the Sharpe ratio and the information ratio etc. (elementary reference points in any discussion about modern investment theory). This has had significant implications for understanding the spread of Anglo-American financial practice to distant shores just as it has significant implications for understanding the standards set by institutions such as the International Accounting Standards Board. The language of finance is built upon three axioms derived from modern portfolio theory (Houthakker and Williamson 1996). These axioms are essential for the whole edifice: first, financial markets are efficient in the sense that they embody all available information relevant to the formation of prices; second, market arbitrage inevitably drives-out market imperfections such that market inefficiency is idiosyncratic rather than systematic; and third, market behaviour is rational in the sense that rational agents dominate irrational agents through the exploitation of the latter by the former.

Institutional investors and the language of finance: the global metrics of market performance
Gordon L Clark, Tessa Hebb, and *Dariusz Wójcik, School of Geography &
the Environment, and *Jesus College, University of Oxford