Incentives & Control Summary Seminar Articles
Bouwens & Kroos (2019)
1.What is the decision that is focal in this study and how is the delegation of decision rights
organized in this setting?
The decision and the focal in this study has to do with approving loans. You have to approve loan,
this means that you have to decide about conditions, and you finally have to approve the loan; thus
are we go ahead with the loan or not? ‘Banks give (their loan officers) decision rights to approve
loans. Loan officers are enforced to make decision on approving smaller loans with small credit risks
by themselves, since they have valuable information. For loans with a higher amount of total
outstanding debt and higher credit risk they have to seek for approval from credit risk managers or
the credit committee. You can see an overview in the table below.
2. What kind of customers are served in this bank and why is this relevant?
They are serving smaller business. So these are smaller firms that want loan. The problem there is
that they don’t have so much ‘hard’ information, because for example the financial statements here
are not audited, so they have a lot of ‘soft’ information, which laon officers accumulate over time.
Because they kind of visit those firms on a regular basis over the year, so they really start to get to
know the owners of the companies. Therefore they start to have an idea whether this is a creditable
party or not. And especially when they find somebody creditable, smart, hardworking, and they have
confidence in the business plans, this is all kind of ‘soft’ information. It is hard to verify, but these
information is valuable for small businesses when you want to approve a loan or not.
3. What is the key problem that emerges when decision rights are organized as they are while
serving the kind of customers that they do?
If you want to, because with smaller loans with smaller credit risks, officer loans can decide on by
themselves, with larger loans with a larger credit risk loan officers have to seek approval. Because a
lot of the information is relatively soft, (what is the qualitify of the owner, the business plans) this
information can be presented in a very optimistic manner. And if loan officers presents information
in an optimistic way, it kind of increases the likelihood that the higher-level officer will aprove the
loan. So the story here is, that especially in a situation where a lot of the information, that is usefull
for decision making, is relatively soft (quality owner/business plans). So this information, if they have
to seak approval from a higher-level officers, can be manipulated/ positively communicated biased
way. This means that, moral hazard means that Loans officers are not going to truthfully
communicate about the loans. But instead are going to communicate about the risk return
characteristics on the loan in a positively biased way.
,4. What are the two components of the riskiness of a loan? In addition, how do loan rates move
(increase or decrease) when the credit risk and total outstanding debt increase? Does this make
sense to you?
What are the two components of the riskiness of a loan? Firs we got two things. The likelihood of
default, so how likely is it that a customer will get into default. And what is the loss when a default
happens? And that of course speaks to the question, how much collateral is there, to secure the
loan? These two components make up the credit risk. That is what we also see in table 4: We got
risk_score (the likelihood that a customer will default) and the collateral (what is the loss when
somebody goes into default). The higher the risk_score, the higher the likelihood that a customer
goes into default, the higher the credit risk. But the more we have collateral, the secured loan, that
will decreases the credit risk. (is relatively significant). The additional questions is: How do laon
reates move when the credit risk and total outstanding debt increase? Looking at table 1: when the
credit risk increases, then the risk premium (definitely included in the loan) goes up. This should
make sense. The more interesting is here: the outstanding debt we see here, when the total
outstanding debt increases, the loan rate decreases. And this is nothing else than a volume discount.
The more you buy, the lower the rate. The larger the outstanding debt, the more you are able to
negociate for a lower rate.
5. What is the main takeaway from Table 5? Is this consistent with the key problem that you
discussed at point 3.
We basically see findings that are consistent with, when loan officers have to seek approval for the
loan at a higher-level officers, they are more inclined to communicate in a positively biased way. That
means that when loan officers are inclined to communicate about the risk (the return characteristics
of the loan in a more positively biased way), they succeed in getting greater discounts on a standard
loan rate, that is one. But after the loans are approved, they perform poor. That means that they are
more likely to get a downgrade in the Laon Quality Code in the years after the loan is approvaed. And
that is exactly what you would expect, if you would positively communicate about the loan in a
positively biased way, you would get more favorable terms now (great discount on the standard loan
rate), but after approval, the loan would perform more poorly, that is a higher likelihood of a
downgrade in the Loan Quality Code.
6. What is the main takeaway from Table 6? Is this consistent with the key problem that you
discussed at point 3.
The loan officers communicate about the loan in a positively biased way, and in this way they get
more favorable terms, it only applies to cases where we do not have audited financial information
about the customers/about those firms/ small businesses. That means that, here we got the effect of
higher level. Thus the story here is, only, because the thing is, the loan officer is incentified to
approve loans, if I have to seek approval from a higher-level officer, the laon officer communicate
about the soft information in a positively biased way. But he/she can only do so, when there is a
strong reliance on soft information decision making. He/she cannot do so when there is auditor
financial information because then the focus will be in decision making on this audited financial
information. There the loan officer has less room to present his/her soft information in a positively
biased way. The audited financial information speaks for itself.
, Campbell (2012)
1. Explain the transition from centralized towards decentralized decision making at this credit
union? Describe the centralized and decentralized decision making system.
First they describe the transition from a centralized towards a decentralized decision making system.
The thing is, in the audit system they have rules, and you have to stick with these rules. If you have a
customer, and this customer wants a loan, you have to apply the rules. You ask for information, you
apply the rules; and than you can or cannot give the loan. In a new system however, the rules will
perceived to be guidelines. You still have some guideliness but in the new system you are able to
deviate form the guidelines. So now you can say: according to the guidelines I should not give you a
loan, but you could provide me with some supplimental/additional information. And based on this
infromation I think it is valide/ there is a reason to still give you a loan. So now, the loan officer in a
decentralized decision making system have this discretion to deviate from the guidelines. Before in a
centralized decision making system, the guidelines where just rules, you had to follow them, in the
new system these are guidelines, which you may deviate them, but of course you have to write down
why you do so. You have to document why you deviate from the guidelines.
2. Describe the new strategy and did it fit with the new decentralized decision making system?
They new system was, building new relationships founded on trust. Have focus on building a
relationship with customers through member advocacy and service. So everything was focused on
putting member first in decision making. So the member (the customer) was realy focal (central). This
regionates with the new strategy, because if you want to put the member first, you need to listen to
the member (customer). You can say you have guidelines but the customer provided additional
information which make sense, therefore I am going to deviate from the guidelines. Rules apply to
90-95% of the cases, but there can be valid reason to deviate from the guidelines. You want to listen
to the customer and to apply the offer to specific circumstances of each customer.
3. Do you believe that this new strategy makes sense given that the organization is a credit union?
According to the professor is this a very interesting question, because this is a credit union. You can
compare the NL to the old system, think of the Rabobank, where the customers are also members of
the bank. And if you have customers who are also members, this means that the financial returns are
not the bottom-line. Because the members are the owners, so at the end of the day, the customer
service is vital. because when the customers are happy, these are the people that you do it / work
for. However, if you look at a listed firm on the stock-exchange, customers that are happy, are
important because it provide financial returns for the shareholders, because these people are
ultimately the owners. So there is a slightly difference emphasize while in listed firms on the stock-
exchange, customers are of course important, because if we don’t have happy customers, we will not
have financial returns. Happy customers are’ immense to an end’. There is a means towards having
shareholder value, because that is the ultimate objective. But at a credit union, the customers are
the owners. So their financial returns are important, because financial returns guarantee the long-
term survival of the credit union. But ultimately, ultimately objective is not financial returns but
having happy members/customers. Because these are the owners, and that is what you ultimately
want. The professor hopes that you see, that if you compare credit union with a listed firm, that the
emphasize is slightly different. Both customer service is important, both financial returns are
important, but for stock-listed firm customer happiness/satisfactions is means to achieve high
shareholder returns, while in the case of a credit union financial returns are important because they
guarantee the long-term survival of the firm, and therefore enables you to keep the
customers/members happy over the long run.
