Karwowski, Ewa (2016) Financial operations of non-financial firms : the case of South Africa. PhD Thesis. SOAS, University of London http://eprints.soas.ac.uk/23646 Copyright © and Moral Rights for this thesis are retained by the author and/or other copyright owners. A copy can be downloaded for personal non‐commercial research or study, without prior permission or charge. This thesis cannot be reproduced or quoted extensively from without first obtaining permission in writing from the copyright holder/s. The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the copyright holders. When referring to this thesis, full bibliographic details including the author, title, awarding institution and date of the thesis must be given e.g. AUTHOR (year of submission) "Full thesis title", name of the School or Department, PhD Thesis, pagination. SUBORDINATE FINANCIALISATION: Financial OperationsA study of Mexico of Non and its- Financial Firms:non-financial The corporationCase of s South Africa JEFF POWELL Ewa Karwowski Thesis submitted for the degree of PhD Thesis submitted for the degree of PhD in economics 2015 2013 DepartmentDepartment of of Economics Economics SOAS,SOAS, University of LondonLondon 1 Declaration for SOAS PhD thesis I have read and understood regulation 17.9 of the Regulations for students of the SOAS, University of London concerning plagiarism. I undertake that all the material presented for examination is my own work and has not been written for me, in whole or in part, by any other person. I also undertake that any quotation or paraphrase from the published or unpublished work of another person has been duly acknowledged in the work which I present for examination. Signed: ____________________________ Date: _________________ 2 Abstract Using South Africa as a case study, this thesis examines what role financial operations play in the activities of non-financial firms and their impact on the macro economy. Rising corporate cash holdings are used as analytical lens to evaluate competing theories. South Africa, with its relatively deep financial markets, has elicited clear predictions from mainstream and heterodox economists. The former expect rapid economic growth driven by business investment, while the latter believe non-financial firms engage in financial speculation, thus reducing growth. While the thesis agrees with the heterodox view that changes in financial activity of South African non-financial corporations have had an adverse effect on financial stability and job creation, it challenges the simplistic view that non- financial firms have engage in more financial speculation. Crucially, since the 1990s non-financial corporations have shifted from using their financial resources to extend trade credit to small and informal businesses, towards active liquidity management. A driving force behind this trend are mining companies and large JSE-listed non-financial (and non-mining) companies, frequently engaged in merger and acquisitions. Thus, large South African non- financial corporations are overcapitalised, meaning they hold more liquid assets than necessary for their productive operations. This shift meant that informal companies, which notoriously suffer from poor access to finance, lost an important source of credit. The thesis argues that non-financial corporations’ liquidity management facilitates credit extension by domestic banks, fuelling the domestic real estate bubble. Changes in financial operations of non-financial companies, under way since the 1990s, have impacted growth and financial stability adversely. Thus, this thesis argues against the mainstream claim that South African growth has been facilitate by the domestic financial sector, while shedding light on the complex processes behind the transformation of non- financial firms’ financial transactions, which are not simply speculative as claimed by financialisation proponents. The originality of the thesis lies in its contribution to the understanding of the processes behind financial operations of non-financial companies, in particular how these firms utilise financial operations to support their speculation in real assets. As consequence, they are overcapitalised. The research also contributes to the growing literature on financialisation in emerging economies. The thesis develops an operationalisation of the concept of overcapitalisation and an original adaptation of existing flow-of-funds analysis of corporate investment. 3 Acknowledgments This work was supported by the SOAS Research Scholarship. I would like to express my gratitude to the SOAS Economics Department. The staff and especially the PhD student community make this place unique and intellectually stimulating. I am particularly indebted to my supervisor, Professor Jan Toporowski, who always encouraged me to read widely, think critically and, despite seemingly overwhelming research loads and looming deadlines, keep pursuing my artistic interests. He was extremely generous with his time, intellectual guidance and academic support – well beyond the normal call of duty of a PhD supervisor. I have also enjoyed important encouragement and academic support from Professor Ben Fine and Dr Stephanie Blankenburg, who were part of my supervisory committee at SOAS. My work greatly benefitted from discussions with other PhD students at SOAS. Here, Nina Kaltenbrunner, Jo Michell and Jeff Powell deserve the greatest recognition for their tireless organisational efforts, which created an active and fertile research environment. Equally, I would like to thank Jennifer Churchill, Mimoza Shabani, Jago Penrose, Bruno Bonizzi, Christina Laskaridis, Mariana Mortágua, Ilara Mahdi, Gilad Isaacs, Nimrod Zalk and many others within the PhD community for stimulating conversations, moral support and their friendship, which crucially contributed to the completion of this PhD. I also thank the Economics Department of Kingston University and my colleagues for their faith in my abilities as lecturer and researcher. Finally, my greatest gratitude goes to my family, friends and my partner who – especially during the past year – have suffered most under my relentless research efforts. Bardzo dziękuję moim rodzicą za ich wsparcie moralne i finansowe podczas moich studiów: Przepraszam że nie mogłam być z Wami częściej! - My gratefulness to my partner, Florian Schäfer, for our thought-provoking discussions, his moral and practical backing, kindness and patience, which vitally supported the process of writing this PhD thesis, cannot be adequately put into words. 4 Table of contents Chapter I: Introduction 13 1.1. Research question 14 1.2. Working hypotheses 17 1.3. Structure and methodology 21 1.4. Data and data sources 25 1.5. Major findings 28 1.6. Research limitations 32 1.7. Originality 33 Chapter II: Literature review: Financial Operations of Non-Financial Firms 34 2.1. Financial operations of non-financial firms in mainstream economics 35 2.1.1. The emergence of corporate finance theory 35 2.1.2. The Modigliani-Miller theorem 40 2.1.3. Asymmetric information 43 2.1.4. Empirical findings on corporate cash holdings 47 2.2. Heterodox approaches to corporate financial operations 52 2.2.1. Marx and the German economic tradition 53 2.2.2. Keynes and Post Keynesian thought 62 2.2.3. The ‘financialised’ firm 73 2.3. Summary and conclusion 82 Chapter III: A Balance Sheet Approach to Financial Operations of Non- 85 Financial Firms 3.1. Balance sheet analysis in mainstream economics 86 3.1.1. The origins of balance sheet analysis 86 3.1.2. The concept of net worth 92 3.1.3. Shortcomings of mainstream balance sheet analysis 97 3.2. An alternative balance sheet approach 102 3.2.1. The overcapitalisation of non-financial firms 102 3.2.2. The gearing ratio 107 3.2.3. Mergers and acquisitions 110 3.2.4. A methodology to measure overcapitalisation 117 3.3. A balance sheet approach for South African non-financial firms 123 3.3.1. The emergence of capitalist firms 124 3.3.2. The mining-finance houses and dominant company groups 131 3.3.3. Firm heterogeneity in South Africa 140 3.4. Summary and conclusion 143 Chapter IV: Balance Sheet Analysis of JSE-Listed Non-Financial Firms 146 4.1. Data and methodology 148 4.2. Balance sheet analysis: The aggregate perspective 153 4.3. Balance sheet analysis: The sectoral level 156 4.4. Balance sheet analysis: The firm level 164 4.4.1. Types of liquidity preferences among the top 20 strongly 195 overcapitalised non-financial firms 4.4.1.1. The sectoral breakdown 195 4.4.1.2. Changes in the role of mining-finance houses 201 5 4.4.1.3. Speculation in mining subsidiaries 204 4.4.2. Types of liquid assets held among the top 20 strongly 206 overcapitalised non-financial firms 4.4.3. Findings from the full set of 132 company profiles 210 4.5. Summary and conclusion 215 Chapter V: Literature Review: The Role of Finance in the Macro Economy 218 5.1. The role of finance in mainstream economic theory 221 5.1.1. The economic orthodoxy of the post-World War II era and its 221 origins 5.1.1.1. Money as a ‘veil’ in classical economic thought 221 5.1.1.2. The Solow-Swan growth model 223 5.1.1.3. Introducing real balances 225 5.1.2. The ‘financial repression’ hypothesis and its critique 227 5.1.2.1. Shaw’s and McKinnon’s work 227 5.1.2.2. McKinnon-Shaw financial development models and 229 policy recommendations 5.1.2.3. Criticisms of the ‘financial repression’ hypothesis 230 5.1.3. The emergence of the current consensus 232 5.1.3.1. Financial deepening revived 232 5.1.3.2. Today’s consensus in historical perspective 234 5.1.3.3. Mainstream finance theory after the financial crisis 237 5.2. Financial markets in heterodox economic theory 241 5.2.1. Marx and ‘German’ economic thought on finance 242 5.2.1.1. Marx’s and Marxist thought on finance 242 5.2.1.2. The lasting influence of Wicksell 247 5.2.1.3.