1. What is the core idea behind agency theory?
2. Can you use agency theory to analyse:
a. the rise and downfall of RBS;
b. the mortgage debt crisis more generally?
3. Who is/are the principal(s) and who is/are the agent(s) in your analysis?
Can you think of one threat that arises from the use of agency theory in developing measures aimed to prevent future banking and/or financial failures?\
The emergency rescue of the Royal Bank of Scotland in 2008 has cost the UK government thus the British taxpayer a huge amount of money. Many people are upset about the high bonuses the RBS management board have received, both because of the outrageously high amount and because the performance of the bank on the long-term was not good at all. According to the agency theory managers do not always act in the interest of the shareholder, but often act in the interest of themselves. The downfall of RBS could have been prevented if managers were not paid out a bonus based on their performance of one year, but rather a combination of a bonus based on their performance of multiple years and a bonus paid out in shares.
The agency theory can be applied when a principal contracts an agent, thus asks the agent to perform a service for him. Of course, the principal expects the agent to perform the service in the most favourable way for the principal. The agent, however, strives for his own utility. The agent often is more knowledgeable on his actions than the principal (information asymmetry), hence the principal cannot always know if the agent really is acting for the principal’s utility. Also, the outcome might not only be dependent on the actions of the agent. Much more factors play a role, which makes it much harder to know whether the agent really is acting towards the interests of the principal or not.
One way of solving this problem, is aligning the goals of the agent with...