“ Many risks come along with big bonuses”
The burst of the housing bubble in the US caused the collapse of financial institutions and the bailed out of banks by governmental institutions resulting in the 2008 financial crisis. One of these banks was the Royal Bank of Scotland who ran out of money. Bankers were blamed for acting out of self-interest and making risky decisions. These failures will be analysed in this essay by giving answer to the following question: “How did agency theory contributed to the 2007 financial crisis?”
Introductory, agency theory discusses the relationship in which one party, the principal, delegates work to another, the agent (Eisenhardt, 1989). The core idea behind agency theory is to through contracting align the interest of shareholders (principal) with that of the managers (agents) in order to maximize shareholders value. Thus, the decision-making is being separated from the party who bears the risk; therefore, problems can arise. Firstly, the principal cannot verify whether the agent has behaved appropriately (the agent and principal have partly di...
The financial crisis of 2007–2008 is considered by many economists the worst financial crisis since the Great Depression of the 1930s. This crisis resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. The crisis led to a series of events including: the 2008–2012 global recessions and the European sovereign-debt crisis. The reasons of this financial crisis are argued by economists. The performance of the Federal Reserve becomes a focal point in this argument.
“Agency relationships are formed by the mutual consent of a principal and an agent.” (Cheeseman, p.487) Our book goes on to cite the Restatement (Second) of Agency,
Investment banks, Rating agencies and Insurance companies are key components of the financial market. In this presentation, I’m going to explain how these three key roles worked together to create the 2008 financial crisis.
Animal Spirits – How Human Psychology Drives the Economy, And Why It Matters for Global Capitalism. ‘Animal Spirits’ is a term used by John Maynard Keynes in his renowned ‘General Theory’ to describe the psychological factors that drive consumer confidence in the economy. During the financial crisis of 2009, Akerlof and Shiller took it upon themselves to expand further on the term, devising five key ideas in which they associate with the phrase in Part I of the text. These key ideas are confidence, fairness, corruption, money illusion, and stories. The authors believe that animal spirits are present in the everyday economy and they must be taken into account otherwise economic policies may not be particularly useful.
A wise man once said “where there is no vision, the people perish”. As chairman of the nation’s largest bank, Ben S. Bernanke guided the United States through the 2008 Economic crisis. The economy facing the worst collapse since the “Great Depression”, the newly appointed chairman had great shoes fill after the mark left by the former chairman Alan Greenspan. However, through the portrayal of leadership, he helped stabilize the country’s monetary policies and avoid a financial collapse. He became one of the most influential figure in American Economic Policies.
In contrast , the shareholder theory organisations or organisation's decision-makers only have the responsibility to their shareholders by increasing the organisation profits and should only make the decisions to increase as much as possib...
The "subprime crises" was one of the most significant financial events since the Great Depression and definitely left a mark upon the country as we remain upon a steady path towards recovering fully. The financial crisis of 2008, became a defining moment within the infrastructure of the US financial system and its need for restructuring. One of the main moments that alerted the global economy of our declining state was the bankruptcy of Lehman Brothers on Sunday, September 14, 2008 and after this the economy began spreading as companies and individuals were struggling to find a way around this crisis. (Murphy, 2008) The US banking sector was first hit with a crisis amongst liquidity and declining world stock markets as well. The subprime mortgage crisis was characterized by a decrease within the housing market due to excessive individuals and corporate debt along with risky lending and borrowing practices. Over time, the market apparently began displaying more weaknesses as the global financial system was being affected. With this being said, this brings into question about who is actually to assume blame for this financial fiasco. It is extremely hard to just assign blame to one individual party as there were many different factors at work here. This paper will analyze how the stakeholders created a financial disaster and did nothing to prevent it as the credit rating agencies created an amount of turmoil due to their unethical decisions and costly mistakes.
Structure and agency are two theoretical terms used to explain the capacity at which we as people are able to be individuals, and to what extent those influences limit our individuality. Structure refers to the ways in which a society is organized. Agency refers to the behaviors and actions of the individuals within the social structure. Agency is limited by the structure due to cultural barriers and inequalities within the structure. In this essay, I will present an overview of why critical theorists are concerned with those inequalities, and I will further identify the problems within the system contributing to the unequal access to the public sphere, relating specifically to class and gender inequalities.
If financial markets are instable, it will lead to sharp contraction of economic activity. For example, in this most recent financial crisis, a deterioration in financial institutions’ balance sheets, along with asset price decline and interest rate hikes increased market uncertainty thus, worsening what is called ‘adverse selection and moral hazard’. This is a serious dilemma created before business transactions occur which information is misleading and promotes doing business with the ‘most undesirable’ clients by a financial institution. In turn, these ‘most undesirable’ clients later engage in undesirable behavior. All of this leads to a decline in economic activity, more adverse selection and moral hazards, a banking crisis and further declining in economic activity. Ultimately, the banking crisis came and unanticipated price level increases and even further declines in economic activity.
Agency Theory or Principal Agent Theory is the relationship that involved the contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals will engage the agent to carry out some services on their behalf and would normally delegate some decision-making authority to the agents. However, as the number of shareholders and the complexity of operations grew, the agent, who had the expertise and essential knowledge to operate the business and company tend to increasingly gained effective control and put them in a position where they were prone to pursue their own interests instead of shareholder’s interest.
Jensen, M.C and Meckling, W.H (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, October, 1976, V. 3, No. 4, pp. 305-360. Available on: http://www.sfu.ca/~wainwrig/Econ400/jensen-meckling.pdf. [Accessed on 20th April 2014].
An agency relationship is formed between two parties when one party (the agent) agrees to represent another party (the principal). Normally, all employees who deal with third parties are considered agents. Principal-Agent relationships are defined as the understanding that the agent will act for and on behalf of the principal. (Cheeseman) The agent assumes an obligation of loyalty to the principal that he will follow the principal’s instructions and will neither intentionally nor negligently act improperly in the performance of the act. An agent cannot take personal advantage of the business opportunities the agency position uncovers. A principal-agent relationship is fiduciary, meaning these obligations bring forth a fiduciary relationship of trust and confidence. As such, an agency relationship is governed by employment law.
Firstly, the main reason for the systematic failure, according to the report was the expansion of the property bubble financed by the banks. Between 2002 and 2008 bankers demonstrated high levels of greed combined with disregard for the risks and gross misjudgement which few bankers’ could disagree with. This was evident from the surge in lending between sectors which was very uneven. Residential mortgage lending and lending to the construction and property sector considerably out-paced growth in all the other sectors combined (see Fig1 15). For instance, lending to this sector increased at an annual rate of almost 45%. This effectively created a property bubble and like all bubbles, they burst, and this heavily influenced Irelands’ financial crisis. This tied with the world- wide economic crisis heavily increased the rate of the crisis.
Solomon, J (2013). Corporate Governance and Accountability. 4th ed. Sussex: John Wiley & Sons Ltd. p.7, p9, p10, p15, p58, p60, p253.
9), agency theory is an important part of Positive Accounting Theory. Agency theory concentrates on the relationship between agents (managers) and principals (stakeholders) (Healy and Palepu 2001). Jensen and Meckling (1976) argue that the agency problem occurs when there is dissimilar interests between managers and stakeholders or when stakeholders cannot monitor the management’s behavior. voluntary disclosure is another tool to mitigate the agency problem, were agency cost would be reduced when managers disclose more voluntary information (Barako et al., 2006) and also when external stakeholders are convinced that directors are acting in an optimal way (Watson et al.,