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THEORY OF FINANCIAL INSTITUTIONS AND POLICY - Assignment Example

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Introduction to Agency Theory: This is phenomena mostly observed in institutions in which management and ownership are separate. This sort of mechanism is found mostly in a corporation, where the management of the organization is delegated to the managers of the organization (Berger and Patti, 2006)…
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THEORY OF FINANCIAL INSTITUTIONS AND POLICY
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Download file to see previous pages Means by which managers can accomplish their malign interest is through compensation plan, perks, bonuses, travelling on corporate expenditure and scamming against the corporation. Introduction to Balance Sheet Approach: In order to check the quality of earnings two approaches are predominantly used, one of these approaches in balance-sheet approach. The aim of this approach is to assess the true magnitude of accruals because it is these accruals which lead to manipulative earnings (Aghion, Bacchetta, and Banerjee, 2004). Thus it is of utmost importance to locate them and rectify the manipulative action to see the true picture of the organization. As a general rule the higher the total accruals are as compared to percentage of assets, the greater the likelihood that earnings quality is low. Remember that accruals can be either a reflection of earnings manipulation or just normal accounting estimations based on future business expectations. It is difficult to determine which one is driving the accruals, but there is evidence that the size of accruals can be used as a rough measure for earnings manipulation (Mulder, Perrelli, and Rocha, 2012). Following are the series of formulas that are used to find the real values of accruals (Pasiouras, 2008): 1. Total Net Accruals = Accrual Earnings - Cash Earnings But the balance sheet doesn't directly tell us what accrual earnings were in the period, so further calculations are required to retrieve this information.  2. End Equity = Start Equity + Accrual Earnings - Cash Dividends - Stock Repurchases + Equity Issuances 3. Accrual Earnings = ? Owners' Equity + Cash Dividends + Stock Repurchases - Equity Issuance = ? Owners' Equity + Net Cash Distributions to Equity 4. Accrual Earnings = ? Assets – ? Liabilities + Net Cash Distributions to Equity 5. Cash Earnings = ? Cash + Cash Dividends + Stock Repurchases - Equity Issuance = ? Cash + Net Cash Distributions to Equity 6. Total Net Accruals = Accrual Earnings - Cash Earnings = [? Assets – ? Liabilities + Net Cash Dist. to Equity] - [? Cash + Net Cash Dist. to Equity] 7. Total Net Accruals = ? Assets- ? Liabilities – ? Cash Reasons for the World Recession: Suppressing Demand of the World Market, leading to declining industrial growth and output, which further results in a negative mood spreading amongst the investors and a negative posture taken up by the overall economy (Torna and DeYoung, 2012). In the United States a housing bubble was being propelled by speculative behaviour. This speculative behaviour was fuelling the U.S economy. Federal Reserve’s irresponsible action to lower the interest rates encouraged a large inflow of foreign funds. This availability led to the creation of easy credit for borrowers, who started taking hefty home loans. As the demand for home loans soared this created an artificial demand in the housing market and an artificial price hike in the housing market. Since there was ample amount of money available in the economy the mortgage lenders started lending at an exponential rate and simultaneously lowered their lending standards. Such conditions helped individuals with poor credit history and those who made the NINJA category (No Income, No Job, No Assets), receive hefty amount of loan from the loan agencies for whatever purpose they see fit (Broeck and Guscina, 2011). Since the property market was on a role and was flushed with money, leading to ...Download file to see next pagesRead More
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