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The Bottom Line Expert Opinion: Financial Engineering

Updated Friday, 16th October 2015

Just what is financial engineering and what are the benefits of its use? Dr Peter Bloom investigates.

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Ideas and doodles on paper The rise of financial sector is perhaps the most important development of contemporary capitalism. This increase in the power and reach of finance has produced new ways of thinking about the economy and business. This episode of the Bottom Line discusses the growing field of financial engineering. Its guests explore its present significance and contemporary issues.

Financial engineering is primarily concerned with risk analysis and profit. For this reason it is not usually associated to long term investment strategies. Indeed a key critique of “financialization” is that it prioritizes short term gains at the expense of a more sustainable investments over a greater period of time. This is particularly true for things such as scientific research – whose gains, as well as the time it takes to achieve them, cannot be easily predicted. Recently, however, scholars have been theorizing the ways financial engineering techniques can be use to positively fund such important scientific research. Kevin Davis investigates this development in his article “Superfunds: an investment vehicle for scientific research”?

There is also an enhanced need to study the effects of finance outside of just its profitability. The financial crisis of 2008 revealed that financialisation has a social impact that extends beyond businesses and the market. Established assumptions about the economy and the free market would dramatically challenged. Is it safe or positive to have so much of the economy revolve around the financial sector? These events call for a potential transformation of how economics and business studies are taught. Atul Shah discusses these issues in his article “It’s time to put the social impact of finance on the curriculum”.

Fundamentally, there are renewed questions over the social value of finance and the corporate model that sustains it. The advanced techniques used to assess risk and maximize profitability are meant to have a “trickle down effect” to workers and consumers. However, in practice it has often enriched shareholders and corporate executives at the expense of other stakeholders. The redistribution of wealth at the top, moreover, decreases productive investment in research and innovation. Jeroen Veldman explores this problem in his article “Fixing the hole in the heart of corporate capitalism”.

However, shareholders can also take a more active role in shaping corporate policy. The concentration of power in a smaller number of individuals can lead to a more closed and less transparent decision-making process. It can narrow a firm’s priorities to simply maximizing short term financial gains. Yet, given the changing business environment, where both politicians and the public are demanding more corporate responsibility and governance – these strong shareholders hold the potential power to change a company’s policies and practices. They can, in this respect, turn to financial engineering to better assess the risks of balancing economic and social goals. Thomas Clarke examines this emerging trend in his article “Shareholder activism: the virtuous and the venal”.

There is also a renewed interest in different forms of financial organization. The shareholder model, which much of financial engineering takes as unquestioned, is the dominant but not the only paradigm of economic management. Cooperatives, for instance, a potentially exciting alternative to established corporate financial structures. They emphasize shared ownership, job security, long term investment, sustainability and social justice. Tellingly, the techniques of financial engineering can be repurposed possibly to assist and strengthen such cooperatives. Race Mathews investigates the potential of cooperatives in his article “The Mondragon model: how a Basque cooperative defied Spain’s economic crisis”.

This article was written to accompany the Autumn 2015 series of The Bottom Line. For more information on the series, visit the series page.

 

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