Essay about How the Downfall of RBS Could Have Been Prevented

Decent Essays
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.
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By pursuing this, the manager (agent) also pursues the goals of the shareholders (principals). At least that is the idea behind it.

The Royal Bank of Scotland - just like many other banks and businesses - paid out its managers considerable bonuses for their performances. Managers at RBS started maximising their bonuses by aggressive actions such as take overs and investing in complex financial products. These actions caused the profits of RBS to grow rapidly, which meant high bonuses for the managers. These actions, however, also meant the stability and financial safety of RBS on the long-term got worse and worse. This was not a problem for the managers as they had already earned their bonuses. A different bonus structure probably would have prevented the reckless actions of the RBS managers.

Bonuses of managers could be paid out in shares which they are obliged to keep for a certain time period, e.g. 5 years. That way the share price on the long term is of importance for the managers and the goal of the shareholders is aligned with the goal of the managers. However, the share price is dependent on much more factors than the performance of just one manager. There is a risk that managers would feel they have little to none influence on the share price and still make risk full decisions. Another possibility would be determining the bonus of a manager on their performance in the long run, e.g. 5 years. A combination of these two bonus
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