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Chapter | The Intellectual Venture Capitalist: John H. McArthur and the Work of the Harvard Business School, 1980-1995 | 1999

The Global Financial System Project

by Robert C. Merton and Peter Tufano

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Keywords: International Finance; Globalized Markets and Industries; Projects; Banking Industry; Financial Services Industry;

Format: Print Read Now

Citation:

Merton, Robert C., and Peter Tufano. "The Global Financial System Project." In The Intellectual Venture Capitalist: John H. McArthur and the Work of the Harvard Business School, 1980-1995, edited by T. K. McCraw and J. L. Cruikshank. Boston: Harvard Business School Press, 1999.

About the Authors

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Robert C. Merton
John and Natty McArthur University Professor, Emeritus

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Peter Tufano
Retired Professor

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More from these Authors

  • Working Paper | 2015

    Customers and Investors: A Framework for Understanding Financial Institutions

    Robert C. Merton and Robert T. Thakor

    Financial institutions have both investors and customers. Investors, such as those who invest in stocks and bonds or private/public-sector guarantors of institutions, expect an appropriate risk-adjusted return in exchange for the financing and risk-bearing that they provide. Customers of a financial intermediary, in contrast, provide financing in exchange for a specific set of services, and do not want the fulfillment of these services to be contingent on the credit risk of the intermediary, even when they are not small, uninformed agents lacking in sophistication. This paper develops a framework that defines the roles of customers and investors in intermediaries, and uses the framework to provide an economic foundation for the aversion to intermediary credit risk on the part of its customers. It further explores the implications of this customer-investor nexus for a host of issues related to how contracts between financial intermediaries and their customers are structured and how risks are shared between them, as well as the consequences of (unexpected) deviations from the ex ante optimal contractual arrangement. We show that the optimality of insulating the customer from the credit risk of the intermediary explains various contractual arrangements, institutions, and regulatory practices observed in practice. Moreover, customers and investors are often intertwined in practice, and so this intertwining provides insights into the adoption of "too-big-to-fail" policies and bailouts by regulators in general. Finally, the approach taken here shows that financial crises may be a consequence of observed but unexpected deviations from the ex ante optimal risk-sharing arrangement between financial intermediaries and their customers.

    Keywords: Financial Institutions;

    Citation:

    Merton, Robert C., and Robert T. Thakor. "Customers and Investors: A Framework for Understanding Financial Institutions." NBER Working Paper Series, No. 21258, June 2015.  View Details
    CiteView DetailsFind at Harvard Read Now Related
  • Article | Harvard Business Review | July–August 2014

    The Crisis in Retirement Planning

    Robert C. Merton

    Corporate America began to really take notice of the looming retirement crisis in the wake of the dot-com crash, when companies in major industries went bankrupt in large part because of their inability to meet their pension obligations. The result was an acceleration of America's shift away from employer-sponsored pension plans toward defined-contribution (DC) plans—epitomized by the ubiquitous 401(k)—which transfer the investment risk from the company to the employee. With that transfer has come a dangerous shift in investment focus, argues Nobel Laureate Robert C. Merton. Traditional pension plans were conceived and managed to provide members with a guaranteed income. And because that objective filtered right through the scheme, members thought of their benefits in those terms. Ask a member what her pension is worth and she'll reply with an income figure: "two-thirds of my final salary," for example. Most DC schemes, however, are designed and managed as investment accounts with the goal of accumulating the largest possible pot of savings. Communication with savers is framed entirely in terms of assets and returns. Ask a saver what his 401(k) is worth and you'll hear a cash amount and perhaps a lament to the value lost in the financial crisis. The trouble is that investment value and asset volatility are simply the wrong measures if your goal is to secure a particular future income. In this article, Merton explains a liability-driven investment strategy whose aim is to improve the probability of achieving a desired retirement income rather than to maximize the capital value of the savings.

    Citation:

    Merton, Robert C. "The Crisis in Retirement Planning." Harvard Business Review 92, nos. 7/8 (July–August 2014): 43–50.  View Details
    CiteView DetailsFind at Harvard Related
  • Case | HBS Case Collection | December 2002 (Revised October 2013)

    Williams, 2002

    Joshua Coval, Robin Greenwood and Peter Tufano

    Williams, a Tulsa, Oklahoma-based firm in various energy businesses, must decide whether to accept a financing package offered by Berkshire Hathaway and Lehman Brothers. The proposed one-year credit facility would provide the firm with financial resources in a difficult period.

    Keywords: Financial Management; Crisis Management; Credit; Capital Structure; Financial Strategy; Financing and Loans; Financial Instruments; Energy Industry; United States;

    Citation:

    Coval, Joshua, Robin Greenwood, and Peter Tufano. "Williams, 2002." Harvard Business School Case 203-068, December 2002. (Revised October 2013.)  View Details
    CiteView DetailsEducatorsPurchase Related
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