Volume 44, Number 173,
April-June 2013
Latin America. Between Financialization
and Productive Finance
Roberto Soto
DEREGULATION AND INNOVATION: THE START OF THE BIG TSUNAMI ( ...continuation )

They have also caused companies to seek income and profitability to keep their share prices increasing. Recent stock market bubbles have caused share prices to rise to levels that do not match productive results, even bringing about significant changes in accounting, the valuation of different components of the balance and the formulation of losses and earnings. As an example, we can look to data from the World Bank regarding market capitalization with respect to gdp in Latin America (price of shares for shares that circulate), which show that capitalization went from 29.3% in 2003 to 70% in 2007, but it fell to 42% by 2011. This data contrasts with levels of productive growth, which are infinitely lower (2.4%, 3% and 2.6%, respectively) than stock market growth.

In this way, business accounting has been restructured around the logic of economic financialization. In other words, it now seeks to increase revenue by financial engineering in markets separate from the product (Guttmann, 2009; Palley, 2007, and others). By producing revenue through derivatives, a clear possibility arises to manage liabilities and capitalization for a company or public entity.

One way to achieve these objectives is to use stock options, for example, which provide the right to buy a company’s shares below market prices. This is what happened in Enron, which issued stock options to its executives as compensation, and used entities with the specific purpose of performing otc derivatives transactions, which allowed it to obtain loans without registering debt, transfer liabilities and/or revenue depending on the objective at hand, or use the Hypothetical Future Value, which consists of recording earnings/losses on financial operations to manipulate share values. These are all typical examples of creative accounting.

These operations are a form of compensation that began in the 1980s. These instruments were given to businessmen and executives to later make it seem as though no value had changed hands. This type of incentive depends on the evolution of the company’s shares in the stock market, that is, the short-term value of the shares because it is easier to improve the appearance of prosperity than improve real profits. It is important to highlight that the main component of remuneration for the most important executives in mega-conglomerates, especially those that are non-financial, are stock options. As an example, we can look to the case of the Yahoo ceo, who had a compensation of 230 million dollars in 2004, although the salary only ranges between 1 and 3 million dollars annually.

With this type of options, companies can deduct taxes from the earnings of their employees when they exercise their options, but the companies do not have to include this cost in their income declarations to shareholders. That is why this type of option allows companies to exaggerate their visible earnings while considerably reducing taxes. Institutional Investors2 (ii) play a key role here, as the negotiators and major shareholders of non-financial companies. They are constantly buying and selling assets to obtain short-term profitability. Because there is pressure to maintain increasing share prices, ii pressure non-financial company executives to satisfy these prices through derivatives markets.

In summary, mega-conglomerates use creative accounting to manipulate their accounting statements, using financial engineering and dfi, with the support of major ratings agencies such as Fitch Rating, Standard & Poor’s and Moody’s. Partnoy (2003) writes that ratings agencies have violated the law by failing to disclose risks associated with bonds issued by conglomerates, giving aaa ratings to structured bonds that are acquired by users, as in the case of Orange County, California in the United States, which was given too-high ratings in December 1994, when it later went into bankruptcy. The same happened in the subprime crisis, when they granted aaa ratings to cdo bonds issued by Goldman Sachs, which meant significant losses for the holders of these instruments and when these agencies granted aaa ratings to the government of Iceland just before its collapse in 2008 (Partnoy, 2003, 2011).

That is why through financial regulation, financial and non-financial (private and public) mega-conglomerates have transitioned to financialization. They have turned attention away from the functional activities of their industry and embarked upon a path towards the financial sector, in this way obtaining higher profits. To do so, it was necessary to engage in all kinds of financial practices that allowed them to achieve this objective, while of course avoiding excessive costs. One of the most emblematic cases was Enron, which was a small natural gas company that soon became one of the largest companies in the United States. Enron traded in derivatives, obtaining large amounts of money. Yet, this dynamic was unsustainable in the long term and in 2001 it declared bankruptcy (Soto, 2010: 119). As Hull (2002) and Treviño (2011) have described, there are cases such as Procter & Gamble, Shell, Metallgesellschaft, Parmalat, China Aviation Oil and others that have gone through similar crises.

2 Primarily made up of insurance companies, pension funds, investment societies and speculative funds (coverage).

Published in Mexico, 2012-2017 © D.R. Universidad Nacional Autónoma de México (UNAM).
PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 192, January-March is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
CP 04510, México, D.F. Tel (52 55) 56 23 01 05 and (52 55) 56 24 23 39, fax (52 55) 56 23 00 97, www.probdes.iiec.unam.mx, revprode@unam.mx. Journal Editor: Alicia Girón González. Reservation of rights to exclusive use of the title: 04-2012-070613560300-203, ISSN: pending. Person responsible for the latest update of this issue: Minerva García, Circuito Maestro Mario de la Cueva s/n, Ciudad Universitaria, Coyoacán, CP 04510, México D.F., latest update: Feb 23th, 2018.
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