Risk Management and Value Creation in ... - Arabictrader.com

Rationales for Risk Management in Banks 75
Classification of the Relaxation of the Assumptions
of the Neoclassical World
The neoinstitutional theory 104 relaxes the rigid assumptions of the neoclassical
world, without (completely) ignoring the results derived under the
neoclassical paradigm. There are various neoinstitutional approaches that
basically try to describe the trade relationships between two or more constituents
of a firm, and which can be differentiated as follows: 105
■
Incentive-based approaches: The nucleus of these approaches is the
separation of ownership and decision/control power in modern corporations.
They can be further differentiated into the following two
branches:
– Property rights theory: The allocation of resources can only be
efficient and optimal when all positive and negative externalities
are internalized. This will only be the case when all property rights
(authority rights, property rights, and disposition rights) are
specified and are tradable in appropriate markets. Even though
this approach provides valuable insights by trying to explain the
effects of legal and institutional rules on the behavior of the various
constituents, it is not helpful in deriving a rationale for how risk
management can create value. We will, therefore, not pursue this
approach in more detail, but will use its results in our discussion
below.
– Agency theory: The delegation of disposition rights from principals
to agents necessitates the alignment of the diverging interests
106 that are caused by asymmetric information (and the fact
that obtaining information is costly), uncertainty, and external
effects, and that can also be the consequence of nonfinancial
preferences. The resulting so-called agency costs can be minimized
via ex ante contractual arrangements. They can be split, 107 on
the one hand, into agency costs of equity, 108 which can be mitigated
by financial leverage, which forces the agents (i.e., man-
104 Also often termed as neoinstitutional economics and finance theory, see Jensen
and Meckling (1976).
105 See for example, Perridon and Steiner (1995), p. 486, who refer to Williamson
(1985), pp. 23+.
106 Agents usually maximize their utility, which is not necessarily in the interest of the
principal.
107 See Jensen and Meckling (1976), pp. 305+.
108 These are, for example, overinvestment and conflicts between shareholders and
will be described in more detail below.