Financial Markets

Financial markets function to transfer capital between buyers and sellers and provide corporations and individuals with sources of investing and raising funds. In this section, you will get to know the types of financial markets in the US economy and their role in corporate governance.

Role of Financial Markets in Providing Feedback to Management

Financial markets can provide feedback to management by showing signals of the demand to supply funds to that enterprise.


LEARNING OBJECTIVE

  • Describe how financial markets can provide feedback to a company's management


KEY POINTS

  • Financial markets function through the interaction of buyers and sellers that determine the price of traded assets. Financial markets provide a sign for the allocation of funds in the economy based on the demand and supply through the mechanism called the price discovery process.
  • Management often has imperfect information about its own business. One way in which managers try to gain feedback on their business is by conducting market research. Financial markets can also provide feedback.
  • These various audiences can provide feedback to management, such as when the stock price rises or declines. However, given that the stock market is prone to oscillation, this feedback can vary in its usefulness for managers making decisions.
  • More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing instruments can be resold, an example being a stock exchange.


TERM

  • feedback
    Critical assessment on information produced

Market Role in Providing Feedback to Management

Management often has imperfect information about its own business, especially its business' value in the outside world. One way in which managers try to gain feedback on their business is by conducting market research to discover what people want, need, or believe. Once that research is completed, it can be used to determine how to market various products.

Financial markets can also provide feedback, demonstrating how potential shareholders view the financial value of one company as compared to its competitors. For example, investors who hold shares in multiple firms in a sector may have more information about the prospects in that sector than the manager of one firm in that sector. In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other, creating an imbalance of power. Financial economists have applied information asymmetry in studies of differentially informed financial market participants (insiders, stock analysts, investors, among others).

These various audiences can provide feedback to management, such as when the stock price rises or declines. That said, the stock market is an example of a system prone to oscillation. It is governed by positive and negative feedback resulting from the cognitive and emotional factors among market participants. This may be the result of data-based fundamental analysis or more sentiment-based analysis, meaning that the feedback from the stock market can vary in its usefulness for managers making short-term and long-term decisions.