Introduction
In the mid 1990s there was an evolution in the developed countries. This evolution caused economies to shift from industrial based to asset based wealth economy. Previously, the economies relied on manufacturing based wealth producing economy to generate wealth which was proven unproductive. Economies have recorded exceptional growth with the adoption of asset based wealth producing economy. This new revolution was termed as the new economy. According to Hengyi and colleagues (2001), the United States had a track record of slow economic growth in early 1970s with the old industrial based wealth producing economy. Around 1995, the economic growth accelerated due to improved productivity. However, the performance was still low averaging to about 1% per year labor productivity level between 1972 and 1995. With the adoption of the new economy wealth production, the recorded growth was 2.65% between 1995 and 1999. The new economy was proven effective and productive in US around that time.
This paper seeks to address the effect of the new economy on the overall corporate performance. The paper will first focus on the emergence of the new economy and discuss some assumptions that were made concerning the new economy. The paper will then outline the differences between the new and the old economy. The next focus will be on the emergence of institutional investors with the so called new economy and the evolution they caused on the old economy companies. Lastly, we shall look at the shareholders value and the effect on the corporate performance.
The New Economy
As defined by answers.com, the new economy is a digital economy characterized by industrial sector with intensive use of information technology, basically telecommunications like internet. In this economy, computer based systems are used in production and distribution channels. The new economy may also represent the evolution in the world of business as a result of adoption of internet technology (Williams, 2000, p.43). During the 1990s US economic expansion, the stock markets emerged which really changed the business sector. The new economy as of 1990s was evidenced by the emergence of the new companies or startup companies. There was also new approach to business activities due to use of new technology, telecoms and media.
In addition, there was a revolutionized way of trade; new methods of purchasing goods and services and delivering them to the consumers. All these new dimensions of trade characterized the new economy. Hengyi and colleagues (2001) stated that digital technology was the key drive in this new economy. This technology brought about several developments; most sectors became knowledge intensive, the cost of information also decreased. The investors and analysts adopted a new way of company evaluation through use of technology and valuation of stock price. As a result, the new companies launched public stock offering and won many investors.
There are several assumptions that were made concerning the new economy, most of which were proven false. First, people assumed that companies will always invest in software and new systems in order to make use of information technology (Kelly, 1998, p.31). As a result, most computer firms made earning estimates which were inflated. These estimates could not be met and in 2000, tech-heavy Nasdaq Company collapsed. The other assumption is that there was stable and risk premiums since stock over bonds were no longer essential. The argument was that, there will be an indefinite increase in the stock market averages which never came true. In fact, the risk increased as well as the stock market volatility. People assumed that, due to the scarcity of the high-tech personnel, companies will never sack employees. People left their jobs and went to start up companies. Unfortunately, with the burst of internet boom, there was a slowdown in the US economy in the early 2000s. Companies started to lay off workers and employees started looking for jobs with stable companies once again.
New Economy vs. Old Economy
Experts argue that, new economy is non existent. What exists is just the old economy with a new look whereby, technology is integrated in business. In the old economy, the wealth was produced through manufacturing and industrial activities while in the new economy, on the other hand, the wealth is asset based and there is a widespread use of technology. According to Williams (2000), the old economy uses manual labor while in the new economy, manual labor is uncommon. Activities are highly mechanized. The industrial production in the new economy is highly mechanized but in the old economy it was labor intensive.
The new economy is better understood to mean a country’s financial and economic infrastructure characterized by widespread presence of intangible assets like services and technology (Kelly, 1998, p.56). The old economy had infrastructures of tangible assets like industrialism and physical manufacturing. The new economy came with internet business and computers to replace the former labor intensive which mainly dealt with tangible commodities.
The Emergence of Institutional Investors with the New Economy
These are organizations that invest huge amounts of money in companies. According to Myners (2000), these institutional investors include pension funds, banks, brokerage firms, insurance companies, investment banks among others. These institutions characterize the new economy. These institutions play a major role in the economy by bringing people in pooling funds together to make huge investments. For instance, in a pension fund, employees contribute some money to a fund which is then invested in a company or companies where an individual employee would not be able to invest. For instance, an individual may not be able to invest in bonds because of their high price but a fund can. Employees are therefore able to invest in heavy instilments through a pension scheme. Funds are able to hold a broad portfolio of investments in more than one company (Myners, 2000, p.67). Institutional investors have a lot of influence in a company because they have voting power. They are able to influence the management of corporations.
Shareholders Value
Industries and companies in the old economy have gone through a drastic change since the arrival of the new economy. They were compelled to pursue share holders value with speculation to invest in the new economy (Tapscott, 2006, p.34). Share holders value implies that the ultimate success of the firm is to increase the wealth due to the shareholders. That is the business aims at increasing the wealth of the shareholders. With the new economy, the businesses resorted to investing in assets offered in the stock market. The old economy companies went public and sold shares and other assets like bonds to the public (Hall, 1994, p.46). The old economy companies changed their course and focused on maximizing the shareholder’s value or wealth maximization goal.
In 1980s there was an argument in the United States that supported governing corporations to create shareholders value. Around that time, there were only small corporations in the US. These corporations were rich and they generated huge revenues. These revenues were allocated on the basis of retain and invest principle (Brancato, 1997, p.45). The corporations retained the earnings and their employees. They invested on human and physical capital. These retentions created foundation for corporate growth. The principle of retain and invest was faced by some problems in around 1970s, the problem related to growth of the corporations and the emergence of the new competitors. Internal growth and mergers led to the high growth of corporations, both in size and dimension with different types of business entities. The companies became unmanageable. Some managers became undisciplined and they pursued their own interest instead of that of the shareholders. Some theorists argued that there is need to distinguish the shareholders and the managers; they regarded the shareholders as the principal to the business and the managers as the agents. This is because the managers worked on behalf of the shareholders and are not the owners of the business. They are the shareholders agents. There was fear that the agents would misuse their positions to defraud the shareholders and pursue interests contrary to those of the shareholders. Their mischief led to poor performance in some companies. According to Brancato (1997), agency theorists felt that there was need for corporate control of the corporation by a takeover market. This would also discipline the managers of poorly performing markets. They used the rate of return for corporate stock to gauge the superior performance and maximization of shareholders value was their creed.
During the 1970s, institutional investors also supported the US economy’s quest for shareholders value. That is how the shareholders value emerged and has since then it has been emphasized in all institutions. The main objective of firms has always been wealth maximization or the shareholders value maximization. There was massive transfer of stockholding from individuals to institutional investors which gave way to takeovers suggested by the agency theorists. This empowered the shareholders to influence the yield and the market value of their corporate stocks. As a result, equity based institutional investing grew tremendously around 1970s.
Effects of Emphasis on Shareholders Value on Corporate Performance
The adoption of maximization of shareholders value by corporation has really revolutionized corporate performance. The corporate performance management has been intensified and this has made corporations to experience excellent performance. The corporate performance management or the business performance management entails managing and close monitoring of the performance of the organization (Gaughan, 1996, p.63). Pursuance of shareholders value has made this process easier and productive. The key performance indicators used includes the return on investment (ROI) and revenue performance which are the main interests of the shareholders. In the same line, other indicators would include overheads level and operational costs.
In US in the late 1970s, the emergence of venture capital and IPOs enabled corporations to fund innovations through the new financial ecosystems. This greatly improved the corporate performance and increased the wealth to the shareholders.
Initially, as mentioned in the earlier chapters, the managers used to be much undisciplined and this deteriorated the performance of the corporations. The emergence of takeover markets to control corporations to safeguard the interest of the shareholders also mitigated the mischief perpetrated by the managers. As a result, the companies made huge profits due to proper control.
Since every undertaking in the organization must be in tune with the wealth maximization policy of the shareholders, it is possible to detect any deviations. Initially, managers used to pursue their own interest behind the curtains. With the wealth maximization policy, the managers have to act in tune with the policy (Gaughan, 1996, p.56). This reduces case of frauds and any other kind of misappropriation. As a result, the company is able to realize a higher financial performance. It is also possible to discipline nonperforming managers and replace them with performing ones. This will also boost the corporations’ financial performance.
The emergence of institutional investors also improves the performance of the corporations. This is because institutional investors are able to make huge investments unlike individual investors. During the IPOs, the corporations are able to raise a lot of money with institutional investors than they would with individual investors only (Hall, 1994, p.87). This will help the corporations to undertake huge investments which will enable them improve their financial performance. The shareholders are also very keen to protect their interest. They are more devoted to ensure the well being of the corporations than they were before. This also boosts the corporate performance.
Conclusion
It is apparent that the new economy has injected great benefit in the world of business. The integration of technology in business operations has greatly improved the performance of businesses. The emergence of institutional investors has also revolutionized investments. Individuals are able to be part of huge investments through pension funds schemes which they would not have pursued on their own. The emphasis put on the shareholders value or shareholders wealth maximization has given corporations a new course. They have become more efficient and improved in their financial performance. Though the new economy may seem as the new look of the old economy, there is much to appreciate in the new economy that were non existent in the old economy. The impact of the new economy is really felt intensely.
Reference
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