Internal Rating Systems and the Bank-Firm Relationship

Valuing Company Networks

Bernardino Quattrociocchi

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137497253
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

This book provides the conceptual and operational tools for understanding the mechanisms for assigning a rating to a network of companies. In it, the author explores the rating systems of corporate networks and analyses the link between rating and an enterprise network.

Part I

Logic and Criteria for the Classification of Networks

1

Enterprise Networks

1.1 Enterprise networks: a reasonable survey

Generically, the enterprise, to achieve the permanent economic conditions necessary for the creation of value and the exploration of economic advantages, continuously promotes relations with the external environment, in particular with other economic organizations, which in some cases may evolve into more or less lasting connections.

Among the many existing types, economic relations between companies are particularly important. These relations, also known as inter-company relations, are classified by function of the object or purpose. In particular, it is possible to identify three important categories for this piece of work:

a) Market relations and financial relations;

b) Institutional relations;

c) Collaborative relations.

The first category concerns the market relations that companies activate to realize their characteristic management, both with regard to operational aspects (provisioning, production, and sale) and financial ones (acquisition, remuneration, reimbursement, and insurance funds). However, market relations can be affected by other types of relationships that companies establish among themselves, aimed at altering the competitive environment in their favor. In particular, institutional and collaborative relations aim to create the aggregation phenomena that will enable the constituent enterprises to respond more strongly and more quickly to pressures and competitive threats. Collaborative relationships are often developed in some specific legal contexts to make the relationship more stable, such as joint ventures or other legal forms.

Therefore, companies establish multiple relationships with a wide range of counter parties. Sometimes these relations take on the character of the exchange of goods, services, and/or information; otherwise they are based on the sharing of goals and the pooling of resources, risk sharing, or development of innovative activities.

1.2 Literature review

The evolution of the increasingly dynamic and competitive existing economic context shows that the reasons for companies to interact in collaborative forms of various kinds can be very different and not easy to summarize. Among these dominant reasons, as an example only, is the search for synergies to reduce supply costs (vertical and horizontal integration) and the necessity of facing up to the growing complexity of the environment or the search for new development opportunities (Goodman and Bandford, 1989; Lazerson, 1995; Golinelli, 2008; Rullani, 2008).

A careful analysis of academic literature allows us to delineate and define the reasons and the causes that drive business aggregation. The range of texts that have talked about the issue of the relations between economic actors spans the natural and social sciences, providing different perspectives of analysis and other organizational theories. Important contributions have been derived from sociology, social psychology, and anthropology. More recently, a decisive impetus for the study of business relationships has been received from economic and organizational sociology and organizational approaches to systems (Olivier, 1990; Grandori and Soda, 1995; Golinelli 2000, 2011).

From a strictly economic point of view, the correct starting point for the analysis of business aggregations is the following: if the company could generate all the resources necessary to support itself, there would not even be a necessity to establish relations with the external environment (von Bertalanffy, 1956). However, as companies are not self-sufficient, sourcing markets and outlets is required to perform the typical production function. Therefore, according to this interpretation, in order to create value through the satisfaction of human needs companies are forced to interact with the external environment. Moreover, the philosopher Michel Foucault writes about the economy and the needs of humanity: “The object of the human sciences is not the man himself, that since the dawn of the world is doomed to work, but the entity that in role of production govern its existence, (…), it arrives, finally, to give a representation of the economy” (Marconi, 2001, p. 15).

However, it is possible to identify five theoretical reference constructs to try to outline the original reasons for business aggregation.

The transactional approach has its origin in the seminal work of Coase (1937), who argues, through the theory of market failure, the necessity to consider the firm and the market as two alternative structures rather than complementary. The company, taking advantage of hierarchy and control procedures, replaces the market with its structure to manage and control activities in order to prevent inefficiencies. This approach is formalized with the proposal of Williamson (1975), which states that the hierarchy–market dichotomy can be explained by the existence of transaction costs, which lead to “economic government forms” of the production process, which are known as “hybrid.” Therefore, the transactional approach leads to recognition of a continuum of governance structures with the hierarchy on one extreme and the market on the other, and in the middle we can find strategic networks. These are configured in very heterogeneous organizations, which have been described as “a stable web of organization forms between different but at the same time correlated organizations” (Soda, 1998).

The transactional cost theory identifies a choice criterion, based on efficiency, between the hierarchy and the market, or rather, between creation (make) within production processes and the acquisition of outside resources (buy). However, with the growth of the enterprise, the hierarchy involves increasingly higher and higher costs of control and coordination (due to increasing integration); meanwhile, the market involves costs of use and control. The choice criterion is based on compared efficiency expressed by the costs associated with each of the two solutions. When the evaluation does not allow a choice, the efficient structure of government transactions takes place in an intermediate solution that includes business aggregation (Table 1.1). Therefore, in accordance with the considered approach, the enterprise pool forms an organizational and intermediate residual between the market and the hierarchy. Only then will it attach to them an independent organizational identity different from both the market and the hierarchy (Richardson, 1972; Rullani, 1989; Lorenzoni, 1997a).

Table 1.1 Theories of business aggregations

Transactional cost theory	Commons J.R., 1934; Coase R.H., 1937; Richardson G.B., 1972; Williamson O.E., 1975, 1985, 1987; Rullani E., 1989; Lorenzoni G., 1997
Industry-based theory	Porter M.E., 1980, 1985, 1991
Resource-based theory	Penrose E., 1959; Chandler, A.D. Jr, 1962, 1977; Lippman, S.A. and Rumelt, D.P., 1982; Daft L.R., 1983; Rumelt D.P., 1984; Dierickx J. and Cool K., 1989; Grant R.M., 1991; Conner K.R., 1991; Mahoney, J.T. and Pandian, J.R., 1992; Peterlaf A., 1993; Amit R.P. and Schoemaker J.H., 1993; Collis D.J., 1994; Wernerfelt B., 1984, 1995; Conner, K.R. and Prahalad C.K, 1996; Coff R.W., 1997; Barney J., 1986, 1991, 2001; Barney, J.B., Wright, M., Ketchen Jr. and D.J., 2001; Makadok, R., 2001; Rugman A.M. and Verbeke, A., 2002; Hoopes, D.G. and Madsen, T.L. and Walker, G., 2003; King, A.W. 2007
Knowledge-based theory	Lorenzoni G. and Lipparini A., 1996; Lipparini A., 1998; Jones C., Hesterly W.S. and Borgatti S.P., 1998; Lanza A. 1999; Wing K., 1999
Theory of systems	Bertalanffy von L., 1940–1968; Beer S., 1969; Usai G., 1972; Saraceno P., 1975; Minati G., 2010; Golinelli G.M., 2000, 2011

Source: Author’s elaboration.

The importance of this vision is the ability to provide a general explanation of the phenomenon of business combinations; its main limitation, however, is that it only considers the operational-production aspect of transactions, ignoring the strategic-competitive components. In fact, it does not appear appropriate for those groups that are in search of market power or opportunities for innovative development.

The industry-based view emphasizes the role played by external conditions on the strategic choices of the company, proposing the structure–behavior–performance paradigm (Porter, 1980, 1985, 1991, 2011) according to which the structural characteristics of the sector determine strategic enterprise actions and results. Therefore, the differences of market structures influence the enterprise’s decisional policy, such that in order to achieve better performance they choose to operate in the most attractive sectors and try to manipulate the competitive force to their advantage, seeking a favorable position compared to the opportunities and threats posed by changing the sector variables. This perspective particularly explains the collusion between companies, but also explains the horizontal relations between firms operating at the same stage of the production chain, conquering new targets or consolidating shares in existing ones.

Resource-based theory, unlike the previous theory, emphasizes the role of internal conditions (firm-specific factors) in achieving a competitive advantage (Penrose, 1959; Wernerfelt, 1984; Barney, 1986, 1992; Dierickx and Cool, 1989; Mahoney and Pandian, 1992; Peterlaf, 1993; Collins and Montgomery, 1995; Coff, 1997). The reasons for a differential advantage, in fact, have to be found in the specific allocation of resources and competences possessed by the company compared to its competitors. Companies differ from one another in terms of availability of resources and competences, and this diversity is the basis of the achievement of different profits. From this perspective, linking with other companies allows a single company unit to access resources of strategic importance covered by other companies, and the whole aggregation can be interpreted as an architecture of resources and competences, which is variously combinable and functional for the strengthening of the individual firm’s performance. Therefore, efforts are aimed at identifying the sources of productivity differentials between the resources, and, therefore, competitive advantage, focused on intangible assets and on knowledge: resource-based theory evolves in knowledge-based or cognitive theory (Wing, 1999). The characteristics of uniqueness and critical points that distinguish some resources, together with their growing importance in current competitive systems, lead to identification of knowledge as the primary source of profit. From this point of view, the pressures toward aggregation result from the necessity to promote the transfer, dissemination, and/or creation of new knowledge between business partners. The integration of a company’s own knowledge and skills with those of their partners results in a co-generative process, the output of which, the knowledge produced in synergy, is a factor that increases the competitiveness of the entire network as well as each of the partners. The cogeneration of knowledge in business coalitions is based on a particular method of learning from interaction (Lorenzoni and Lipparini, 1996; Lipparini, 1998; Lanza, 1999), which is based on mutual exchange and enables development of technical, technological, and organizational skills. This perspective allows account to be taken of all those combinations aimed at developing innovative or product diversification strategies through linkages with partners that are already present in other markets. Despite the two theoretical approaches being conceptually different, and consequently only effective in explaining certain types of coalitions of businesses, there is a common thread that can certainly be tracked, and their joint consideration contributes toward gaining an understanding of the entire phenomenon.

It is possible to confirm, then, that organizational efficiency is an essential component of a competitive advantage that is defensible over time, and that precisely the characteristics of the current hyper-competitive context are necessary to make the growing push for the sharing of resources and knowledge available for the enterprise. An important contribution to this is contained in the definition of network offered by Jones, Hesterly, and Borgatti (1998), which identifies grouping of companies as an organizational model that allows the most effective response to market conditions, such as those existing at the time of writing, in which the uncertainty of demand predominates, and more generally the environment, the complexity of tasks, and the frequency of transactions.

The theory of systems was introduced in the 1940s, but interesting contributions were also provided in the previous decades. The biologist Ludwig von Bertalanffy is undoubtedly one of the foremost proponents of the theory of systems, sufficiently so to claim in a paper the role of first proponent in this field of study. He writes: “I was the one who introduced, thirty years ago, the idea and the name of the General Systems Theory” (von Bertalanffy, 1968, p. 12). This theory has definitely contributed to the success of the “theory of systems,” in particular to the “theory of open systems,” namely, that category of entities that in the past had been neglected, as it had not yet been specifically identified. Scientists were referring without distinction to “systems” but, in fact, only referred to “closed systems.” Von Bertalanffy not only proposed the distinction between closed systems and open systems, but he has also highlighted the theory and practice thereof. In the second half of the last century, this theory has had a remarkable expansion in many scientific fields, including the Social Sciences. The positive results of the use of it were certainly remarkable, so much so that it is generally accepted that it has had an important function for the successful evolution of scientific thought and related practical implications.

According to the theory of systems, the first property that qualifies the “vital system” lies in the system’s ability to survive in a particular context. This approach is confirmed by the account of the company as an open system in an environ...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• List of Figures and Tables
• Introduction
• Part I: Logic and Criteria for the Classification of Networks
• Part II: Governance and Path Assignment and Quantification of the Network Rating
• Part III: Guidelines in Calculating the Premium Network
• References
• Index