7 - Agency and accountability: managing other people’s money

Summary

A common joke on Wall Street and in the City of London is that once investment banks started significant trading on their own account in the wake of the Big Bang, they no longer had any need for clients – except to dump their loss-making deals on when things went wrong. In fact, banks are very careful to keep their proprietary and client trading activities separate (indeed, they have to by law), but the joke highlights the fact that traders are not generally trading with their own money and it reflects a general perception that they might behave differently depending on whose money it is. Most financial traders are employees, trading with and risking other people’s money rather than their own. In some cases this is their firms’ money. In many cases it is their clients’ money. This raises a range of ethical issues, some of which we shall consider in this chapter. To set the context, we begin with some reflections on the relationships involved, from both economic and ethical perspectives.

Agency and accountability in economics and ethics

In the world of finance it is common to think of relationships in terms of economic agency theory. Agency problems arise when one party, the principal, engages another, the agent, to act on their behalf, and the interests of the agent differ from those of the principal. Agency relationships of this kind are ubiquitous. They arise not only whenever someone is formally employed, but also whenever one party becomes dependent on the behavior of another and whenever people undertake joint projects (in which case each is agent to the other as principal).