Incentives Problem in Financial Markets - Report Example

Incentives Problem in Financial Markets Incentives Problem in Financial Markets The absence of collective opinion on incentives allotment has caused enduring uncertainty in financial market. Almost all profit motive organizations including banks provide some extra benefits called incentives to their employees with intent to make use maximum of their potential. Even though the incentives system is the best developed tool to enhance the financial activities of an organization, the wrong selection of the instrument would cause financial crisis. At the same time, lack of a well organized incentives system will also pull back the managerial persons from undertaking risks. The Association of Chartered Certified Accountants (ACCA) points out that financial crises arise in institutions as a result of their failure to appreciate and organize ‘the connection between the risks inherent in their business activities and remuneration incentives’ (Hudson,2009, p.3). To illustrate, as Milkovich, Newman and Ratnam (n.d. ) state, the employees resist adopting new production technology as they are concerned about ‘subsequent increase in production standards’. Similarly they will not suggest any ideas for improvement of production from their experience because of the same reason. In addition, the experienced workers do not like to cooperate with job- training programs since they wish to work for themselves aiming at incentives (Milkovich, Newman & Ratnam, p.261). So, all these factors cause an organization to reduce its productivity and thereby subsequent fall in their profitability. The fall in the net profit adversely affects reputation of the company in the financial market as investors hesitate to invest. Similarly, in the case of firms which promote incentives on the basis of volume of extra work often fail to consider the efficiency of the additional work performed by the employees. In order to earn maximum incentives, employees tend to give priority to rapidity rather than accuracy which presumably result in inefficient operations of the total program. All these structural disorders adversely affect the performance and economic stability of the organization. According to Morton and Williams (2010), “financial incentives crowd out intrinsic motivations and lead to worse task performance.” (p.356). Financial incentive system is mainly introduced with the objective of inspiring managers to undertake business risks in accordance with the interests of the shareholders. In contrast, sometimes it makes some adverse impacts on the organizations and consequently on financial markets. The negative aspect of the strategy is that managers motivated by incentives tend to abuse their position by availing unfair favors to vendors as well as to buyers in order to maximize their earnings. As a result, shareholders laze to waste their money investing in such firms as it is against their vital interest. Furthermore, new entrants in the market struggle with difficulties since they have no idea about the implementation of incentives system. It should also be noted that the effective installation of an incentive system imposes a financial burden on the management in addition to its complexity. As Stiglitz (n.d.) states, increased care on incentives causes firms to reduce their attention on returns and often leads to bankruptcy (p.5). In addition to employee incentives problems, there are difficulties persisting in the field of customer incentives. For instance, sometimes banks provide additional incentives to its potential customers in order to keep them for a long time. So, banks do not often increase the interest rates in order to avoid incentive effects associated with increased interest rates, even if the demand for credit is high. This unusual practice would adversely affect bank’s traditional concept of profit maximization. Banks’ incentive structures aim at achieving short term objectives which do not support risk management or long term interests of the shareholders. Incentives play a crucial role in lending and monitoring of bank loans. The nations characterized by demographic difficulties are forced to provide incentives to insurance companies in order to stimulate its services in the public sector and health care. Incentives problems also take place “when one party of a financial transaction has the information that the other party does not, or one party acts as an agent of the other” (Curak, Loncar & Poposki, 2009, p. 1). The financial institutions also face the incentive problems when they are compelled to grant incentives for market surveys and customer feedback programs. Thus equity market as a whole struggles to overcome the ongoing incentives problems in the financial market. The edgy problem is that incentive problems exist among regulators too. The regulator may posses some private interests in addition to the ultimate objective of financial stability. As Schuler (n.d.) opines, regulators’ interest may differ from that of agents on the ground of information, accountability, and enforceability which result in an incentive problem since these factors are essential for the formulation of an effective incentive structure. (p.3). Geographical specialties, religion, living standard of the people, and varied utility consumptions are some of the factors which cause incentive problems among regulators. The unnecessary competition between regulators weakens proper incentives system monitoring since they cannot give enough care to it. So, they fail to ensure that agents take prudent actions in order to prevent unforeseen contingencies. It affects financial market to a great extent by causing depression since the regulators are the policy makers for their agents. In the same manner, different organizations exercise different incentive systems, which pull back regulators from forming effective future crisis policies. The absence of a well developed incentives formulation system intensifies the raggedness of the situation. The undue influence of the business magnets through political pressures would greatly cause the incentives issues among regulators. Similarly up to date market observation and market forecast are necessary for the development of an efficient incentives structure. It also requires complex clerical works and services of financial experts. This all processes cause to enlarge the figures of administration costs, which produce a huge barrier for regulators against the effective management of incentives system. Often regulators may not have thorough knowledge about the scientific and structural aspects of various factors associated with incentives planning. In addition to this, organizational structure and corporate governance are also playing some interrupting roles in the formulation of well-organized incentives structures. Since a company always needs to preserve the interests of the stakeholders, the regulators also are compelled to consider the likes of the shareholders. Likewise unfitted government regulations and policies may also become a crisis for the incentive development programs. Even though considerable efforts have been taken for the improved management of incentive control, still it is an insoluble problem in financial markets and among regulators. The incentives problems among regulators worsen the economic imbalance of the country. No doubt, incentives are the best tools to support the economic growth of organizations; but the mode of operation of this instrument will decide the success or failure of the financial market. References Curak, M., Loncar, S & Poposki, K. (2009). Insurance Sector Development and Economic Growth in Transition Countries. International Research Journal of Finance and Economics, Euro Journals Publishing, Inc. Hudson, V. (25 Nov 2009). ‘Parliamentary Briefing the Financial Services Bill’. ACCA. Retrieved 3 Dec 2010 from http://www.accaglobal.com/pubs/about/public_affairs/unit/parliamentary_briefings/fin’ancial_services_bill.pdf Milkovich, G. T., Newman, J. M & Venkata Ratnam. Compensation. New York: Edition-9, Tata McGraw-Hill. Morton, R. B & Williams, K. C. (2010). Experimental Political Science and the Study of Causality: From Nature to the Lab. New York: Cambridge University Press. Schuler, M. (n.d.). “Incentive Problems in Banking Supervision- The European Case”, Discussion Paper No. 03-62. Center For European Economics Research. Retrieved 28 Nov 2010 from http://www.econstor.eu/bitstream/10419/23996/1/dp0362.pdf Stiglitz, J. E. (n.d.). Financial Markets and Development. Oxford Review of Economic Policy. Retrieved 28 Nov 2010 from http://www.unicef.org/socialpolicy/files/Financial_Markets_and_Development.pdf Read More