make the life of poor performers at the least uncomfortable. Finally, bad performers are subject to the threat of takeover. If the board of directors is lax in monitoring management, unhappy shareholders in principle can elect a different board. They do this by launching a proxy contest in which they seek to obtain enough prox- ies (i.e., rights to vote the shares of other shareholders) to take control of the firm and vote in another board. However, this threat is usually minimal. Shareholders who attempt such a fight have to use their own funds, while management can defend itself using corporate cof- fers. Most proxy fights fail. The real takeover threat is from other firms. If one firm observes another underperforming, it can acquire the underperforming business and replace manage- ment with its own team. The stock price should rise to reflect the prospects of improved per- formance, which provides incentive for firms to engage in such takeover activity.     1.3 CLIENTS OF THE FINANCIAL SYSTEM   We start our analysis with a broad view of the major clients that place demands on the fi- nancial system. By considering the needs of these clients, we can gain considerable insight into why organizations and institutions have evolved as they have. We can classify the clientele of the investment environment into three groups: the household sector, the corporate sector, and the government sector. This trichotomy is not perfect; it excludes some organizations such as not-for-profit agencies and has difficulty with some hybrids such as unincorporated or family-run businesses. Nevertheless, from the standpoint of capital markets, the three-group classification is useful.   The Household Sector   Households constantly make economic decisions concerning such activities as work, job training, retirement planning, and savings versus consumption. We will take most of these decisions as being already made and focus on financial decisions specifically. Essentially, we concern ourselves only with what financial assets households desire to hold. Even this limited focus, however, leaves a broad range of issues to consider. Most house- holds are potentially interested in a wide array of assets, and the assets that are attractive can vary considerably depending on the households economic situation. Even a limited con- sideration of taxes and risk preferences can lead to widely varying asset demands, and this demand for variety is, as we shall see, a driving force behind financial innovation. I. Introduction 1. The Investment Environment The McGraw−Hill Companies, 2001