Question

Scenario: Kim Weathers, CEO of Southwest Idaho Bank and Trust, has decided to retain the bank’s corporate jet at a time most of the bank’s competitors have sold theirs. The bank has built a reputation for being an expert in taking care of the needs of a diverse, specialized segment of customers such as cattle ranchers in Montana and western Texas as well as almond growers in California. Ms. Weathers has determined that the bank’s executives, including her, need to be able to travel to meet with her clients on short notice, and the only way to be able to do this is to retain the corporate jet.

Stock analysts, wary of the bank’s decision to retain the jet, estimated that the bank generated an additional $26,000,000 in revenue in 2019 that the bank otherwise would not have made if it hadn’t kept the jet. External accountants were able to compute the all-in cost of the jet to the company in 2019 as being $20,000,000. There is no evidence the jet was used on non-official bank business.

Is this an Agency problem? (yes or no)

Why is this or is this not an agency problem? (1-2 sentences)

Is there an agency cost involved? (yes or no)

If there is an agency cost involved, describe it, and indicate whether it is a direct or indirect cost. (1-2 sentences)

If it is an agency problem, what could be done to alleviate or prevent it? (1-2 sentences)

Answer 1

No, This is not an agency problem since the stock analyist is not conflicting on its decision of holding the jet. Rather it is of the opinion that the jet is promoting the revenue of the Bank. It stated that the bank made an additional revenue and that it wouldn't have achieved it had they sold the jet.

However, there could be an agency cost involved since that materiality of the expense is significant. And such an expenditure is incurred at the expense of the shareholders. Hence, this is an indirect cost.

Agency problem can be prevented or alleviated and that depends on the type of the institution. Keeping in mind the provisions of the act that governs the Bank, the bank can allow the agent to opt for an option of buying the shares of the bank or any other kind of incentive in addition to the commission etc. Agency cost cannot be eliminated completely but it can be prevented in particular.