Agency Theory In Banking Sector

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This paper summarizes prior research regarding franchising in the banking sector, the level of risk in the business approach of bank managers and the role of the agency theory in this sector. High-value-franchises tend to use a less risky business approach than low-value-franchises because franchisors prefer less risk when having a high-value-franchise. The incentives of franchisees and franchisors thereby need to be aligned to lead to higher company profits. Intro It is evident that the banking sector goes paired with risk-taking decisions and going through risk involving processes (Demsetz, Saidenberg and Strahan, 1996). Risk-taking, however, does not go paired with having a franchise that is considered as a franchise with high value.(Demsetz…show more content…
This theory enables to solve problems between the agent (such as company executives) and their principal (shareholders) and addresses two main problems. The first problem is a misalignment in the goals of the principal and agent with the principal unable to monitor the agent (Ross, 1973). The second problem occurs where is a different attitude towards risk taking where agents might take more risks if their incentives stimulate to do so (Ross, 1973). The agency theory can be applied in the context of franchising, with the franchisee as the agent and the franchisor as the principal. Lafontaine (1992) described that franchising includes risk, moral hazard on the side of the agent, moral hazard on the side of the principal, the capital requirements of the franchisor and the information asymmetry between both sides. Lafontaine (1992) performed an empirical research regarding this subject which resulted in incentive issues on both sides of the franchising contract. This result aligns with the empirical research by Norton (1988), who found that franchising is more often used when there is an incentive or monitor problem downstream. Lafontaine (1992) argues that franchisees are more motivated than hired managers and that this is one of the biggest advantages of…show more content…
An alignment of the incentives of the agent (managers) with the interest of owners will lead to a higher profit than when a manager acts in its own interest (Baiman, 1990). This finding can be applied to the banking sector due the fact the franchisee will act with a less risky approach in doing business because the franchisor prefers a high-value-franchise (Keeley, 1990). Demsetz et al. (1996) argue that the banking sector requires good on-site examinations and off-site surveillance, while Tosi, Katz and Gomez-Meija (1997) mention that active monitoring is considered as less effective than incentive alignment by equity holders (franchisors) when cons ide ring the business approach of agents. In addition, agents are stimulated to improve personal wealth when this wealth has a strong link with the principals of the firm (Coffee, 1988; Mehran 1995). Coffee (1988) and Mehran (1995) adds that firm executives will act with the same level of risk as is preferred by their principals, which implies the selection of riskier strategic options. This, however, is contrary with a high-value-franchise in the banking sector. The principals of franchises in the banking sector choose a less risky

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