Question

If the directors and managers of a financial institution (bank)  have large ownership of firms shares how it can it lead to agency and stakeholders problem.

Also, how it can lead to a corporate goverance  failure?

Answer 1

Agency Problem:

• Agency is a relationship between parties where one is expected to carry out activities and take decisions in the best interest of the other.
• When there is conflict of interest between the parties, it leads to agency problem because either one or both are not acting in favour of the other.
• In the given case, the directors and managers of a financial institution (bank) have large ownership of shares, thus, the main decision making authority rests in their hands.
• Due to the large ownership by directors and managers, they can take decisions that are not in the favour of the general shareholders.
• They can misuse their rights and falsify accounts.
• Also, they can work for their self benefit, retaining most of the profit for themselves and can approve big decisions that are not in the benefit of the company.
• As there is conflict of interest because of large ownership and a risk that a wrong decision will be taken, there is Agency Problem.

Stakeholder’s Problem:

• The disagreement on taking various business decisions between the stakeholders of the company is also an issue.
• Because most of the stakeholders are the employees of the company itself, they can take and approve decisions that will benefit them but not the general shareholders.
• Value maximisation objective will be set aside and they can also involve themselves in fraudulent transactions.
• Thus, there is stakeholder’s problem too.

Corporate Governance Failure:

• The way in which the rules are laid and business activities are carried out to ensure that the company is working effectively and efficiently, taking shareholders into consideration is called Corporate Governance.
• The goal is to reduce the conflict of interest between various stakeholders.
• As most of the shares are owned by insiders, such policies can be framed that benefit them rather than benefitting all.
• Also, the company can venture into deals that are unethical and hamper the working efficiency of the company. Hence, it can lead to Corporate Governance failure.