Case Study based on Agency Problem

About Lehman Brothers

O Global Financial Services Firm
founded in 1850 and bankrupted in
2008( year 11 years ago)
O It was 4th largest investment bank in
USA.
O Operated for 158 years.
O 2006 Best Infrastructure Initiative
award
O Lehman listed assets of $626
billion and liabilities of $560
billion for a net worth of $66 billion,
according to a study by economists
William Cline and Joseph Gagnon of
the Peterson Institute.
 The Problem
O Lehman Brothers’ employees’ having a very small
piece of the company ownership does not guarantee
that they will act in the best interest of Lehman and
effectively manage its risks.
O Lehman’s taking excessive risks was a classic
example of them, agency problem because
employees and executives acted in their own best
interest, which was performance-based
compensation.
O Shareholders hire third parties, directors, to minimize
such agency problem between shareholders and
employees including executives.
 Result
O Due to personal interest of both director and
employees, the principle (shareholders)
faced the agency problem.
O The problem can be generalise under
O Moral hazard(hidden action)
O Adverse Selection(hidden characteristic)
O Agency cost (conflict of interest)
 Suggestion for
Lehman Brothers

If Lehman were incorporated as a partnership firm such

as general partnership or limited partnership where
general partners put their own capital on the firm and
personal unlimited liability, those partners would object
to such a high risk. As for which bankruptcy won’t have
occurred.