“Know other, know self, hundred battles without fear.” Sun Tze's Art of War
This is often due to the uncertainty and distrust caused by “Information Asymmetry”, a term used by economists and game theorists to describe negotiating situations in which the parties do not have the same full set of information. As such, one party may have a competitive or unfair advantage over the other because of proprietary information.
This unfair advantage can lead to one of two possible problems:
Adverse selection: immoral behaviour that takes advantage of asymmetric information before a transaction. For example a poor person may be more inclined to acquire loans than someone who is rich.
Moral hazard: immoral behaviour that takes advantage of asymmetric information after a transaction. For example, someone may be inclined to over spend by drawing down the debt facility he or she just took out.
To improve negotiated performance, economists argue that exchange of information must take place and it has to be done effectively and efficiently. However, in practice, the exchange of information between banks and corporate borrowers is often impeded by suspicion that the other party will use it to exploit the situation.
Let’s examine how corporates can manage the information asymmetry to improve the negotiated performance.
From the corporate borrowers' perspective, banks are the few sellers (in fact, only four majors and two regionals) of debt capital and banking services to thousands of corporate buyers. We must understand that sellers in this kind of oligopoly market under heavy regulations have low tendency to compete on price or quality. They would only try to differentiate their almost homogenous products (debt capital and transactional services) from each other.
Banks have been trying hard to communicate to the corporate market their uniqueness, such as having an Asian regional strategy, breaking the ranks with rates, adding values. However, they aren’t gaining competitive advantage in their negotiations with corporate borrowers as these information is not proprietary - most of these corporate borrowers are oblivious of the various differentiated value propositions presented by banks. This proves that banks have been ineffective in disseminating appropriate information to corporate borrowers.
On the other hand, the appropriate information such as, the inter-related pricing and credit analysis methodology which directly impacts on buyers’ hip pockets are concealed by banks either knowingly or unknowingly. For example, some cunning, experienced bankers may package this valuable information in a way that maintains bargaining power over their customers whilst the inexperienced bankers are often just too green to even understand themselves, let alone explain appropriately to customers.
Whilst this information asymmetry may have given banks the short-term upper hand in some banking relationships, it surely creates long-term distrust in relationships with corporate customers. One can imagine the potential competitive advantage corporate borrowers could gain if they intimately understand how bank works.
Let’s look at this situation from the banks' perspective. Despite the common conception that the corporate borrowers are customers of banks, one can argue that banks are buyers of corporate debt instruments, hence customers to corporate borrowers. Following this logic, thousands of Australian corporate borrowers are in fact competing to sell their corporate debt to the few banks in this “perfect competitive market”.
Economists explain that sellers – corporate borrowers – in this type of market have little to no market power to set their price unless they can break away from their peers by effectively differentiating their products – debt – from competitors.
This is where the larger, institutional corporate borrowers, such as BHP or Telstra, have demonstrated success in effectively and efficiently managing the information asymmetry so as to differentiate their debt from that of average corporate borrowers.
They often have ex-bankers on their side either as their in-house treasurers or external advisors to manage information exchange. Whilst they have first-hand knowledge on how to present information to ensure coherence and relevance, they also know how to maintain the appropriate level of information asymmetry to create healthy competitive tension among banks. All these information are then effectively communicated to the capital markets via very efficient means: rating agencies and their internal investor relations.
The continuous disclosure of timely and meaningful information by these companies put banks at ease as it helps mitigate the potential negative outcome of adverse selection and moral hazard. The same also applies to the way they disseminate information on their transactional banking needs, volume and flow to their relationship banks. Their superior strategy means many banks compete for their banking business and so these institutional corporate borrowers achieve competitive debt facilities and services.
It would be an uneconomical exercise for any companies with banking facilities of less than $150m to embark on the excessive investment journey of obtaining public ratings or establishing their in-house investor relations teams. Nevertheless, mid-tier corporates ought to be cognisant of the importance of managing information asymmetry in achieving a successful and supportive banking relationship.
As SunTze’s Art of War said, “Know other, know self, hundred battles without fear.”