What are the different types of stakeholders and key principles which underpin the stakeholder concept?

Do you agree with the traditional theory that assums profit maximization as the the sole objective of abusiness firm.list your arguments in favor of or against this theory?

The traditional theory of the firm tends to make a standard assumption that businesses possess the information, market power and motivation to set a price and output that maximises profits in the short or long run. This assumption is now criticised by economists who have studied the organisation and objectives of modern-day corporations and in particular the existence of a 'divorce of ownership and control' that is common to most large scale corporations.Why might a business depart from profit maximisation?There are numerous possible explanations. Some relation to the lack of accurate and detailed informationrequired to undertake optimal maximising behaviour. Others concentrate on the alternative objectives of modern businesses. We start first with the effects of imperfect information.Imperfect information about Demand and Cost ConditionsOne reason why firms might depart from profit maximisation is that it is difficult for them to identify their profit maximising output, as they cannot accurately calculate marginal revenue and marginal costs. Often the day-to-day pricing decisions of businesses are taken on the basis of "estimated demand conditions" rather than a systematic calculation of a demand curve. Most modern businesses are multi-product firms operating in a range of separate markets. The amount of information that they have to handle can be vast. And they must keep track of the changing preferences of consumers and ever-evolving market conditions. The idea that there is a neat and single profit maximising price is really redundant.Behavioural Theories of the FirmBehavioural economists believe that modern corporations are complex organizations made up of various groups or stakeholders. Stakeholders are defined as any identifiable groups who have a vested interest in the activity of a business. Examples of relevant stakeholders might include:Employees within a businessManagers employed by the firmShareholders - people who have an equity stake in a businessCustomers in the marketThe local communityThe government and it's agencies including local governmentEach of these groups is likely to have different objectives or goals at different points in time. The dominant group at any moment in time can give greater emphasis to their own objectives - for example price and output decisions may be taken at local level by managers - with shareholders taking only a distant and imperfectly informed view of the company's performance and strategy.Behavioural EconomicsBehavioural economics is a relatively new field of economics which looks directly at the way human behaviour and decision-making is modelled. By integrating economics with psychology, economists can benefit from the experience psychology has in examining our behaviour. Indeed many psychologists are teaming up with economists in an attempt to study human beings in the economic forum, the most recent team being the 2002 Nobel Prize winners Daniel Kahneman (a cognitive psychologist) and Vernon Smith (an experimental economist).For the first time, laboratory experiments are being used to provide serious empirical data for economists to study. These experimental economists use techniques borrowed from psychology to test human subjects in a controlled experiment. As methodology improves, such experiments are slowly gaining more credibility within the economic academia.Source: Jack Wills, Behavioural Economics and Rational Behaviour, 2003If firms are likely to move away from pure profit maximising behaviour, what are the alternatives? The reality is that there are numerous different strategies that can be employed. Although a business might have profitability as an important medium-term aim, it might depart from this in the short term.Here are some alternatives to pure profit maximisation strategies:Satisficing behaviour involves the owners setting minimum acceptable levels of achievement in terms of business revenue and profit.Sales Revenue MaximisationThe objective of maximising sales revenue rather than profits was initially developed by the work ofWilliam Baumol (1959). His research focused on the behaviour of manager-controlled businesses - price and output decisions taken by managers are divorced from the shareholders (the owners of the business). Baumol argued that annual salaries and other perks might be more closely correlated with total sales revenue rather than profits. Companies geared towards maximising revenue are likely to make frequent and extensive use of price discrimination (or yield management) as a means of extracting extra revenue from consumers.Managerial Satisfaction modelAn alternative view was put forward by Oliver Williamson (1981), who developed the concept of managerial satisfaction (or utility). This can be enhanced by success in raising sales revenue.Constrained Sales Revenue MaximisationShareholders of a business may introduce a constraint on the decisions of managers - known as constrained sales revenue maximisation. For example hey may introduce a minimum profit constraint designed to underpin the valuation of their shares and maintain a dividend.The diagram below shows how price and output differs if the firm changes its objective from profit to revenue maximisation. Assuming that the firm's costs remain the same, a firm will price lower and produce a higher output when sales revenue maximisation is the main objective.The profit maximising price is P2 at output Q2 whilst the revenue maximising price is P1 at output Q1. A change in the objectives of the business has an effect on economic welfare and in particular the balance between consumer and producer surplus. Consumer surplus is higher with sales revenue maximisation because output is higher and price is lower.Price and Output under Constrained Profit MaximisationShareholders might attempt to "constrain" the price and output decisions of managers by introducing aminimum profit constraint.Consider the following diagram on the next page:The normal profit maximising output is at Q2 (where the vertical distance between the total revenue and total cost curve is at its greatest)Revenue is maximised at output Q1 where the total revenue curve reaches a maximum (i.e. marginal revenue is zero)If shareholders insist on the business achieving a minimum profit as shown, then the managers of a business have the discretion to vary price and output anywhere between Q2 and Q4At any output beyond Q3 (where total revenue and total cost intersect) losses are madeThe short run supply decision - the shut-down priceThe theory of the firm assumes that a business needs to make at least normal profit in the long run to justify remaining in an industry but this is not a strict requirement in the short term. In the short run the firm will continue to produce as long as total revenue covers total variable costs or put another way, so long as price per unit > or equal to average variable cost (AR = AVC).The reason for this is as follows. A business's fixed costs must be paid regardless of the level of output. If we make an assumption that these costs are sunk costs (i.e. they cannot be covered if the firm shuts down) then the loss per unit would be greater if the firm were to shut down, provided variable costs are covered.ATC �Consider the cost and revenue curves facing a business in the short run in the diagram above.Average revenue (AR) and marginal revenue curves (MR) lies below average cost across the full range of output, so whatever output produced, the business faces making a lossAt P1 and Q1 (where marginal revenue equals marginal cost), the firm would shut down as price is less than AVC. The loss per unit of producing is vertical distance ACIf the firm shuts down production the loss per unit will equal the fixed cost per unit AB.Deriving the Competitive Firm's Supply Curve in the Short RunIn the short run, the supply curve is the marginal cost curve above average variable cost.In the long run, a firm must make a normal profit. When price = average total cost, this is the break-even point. It will therefore shut down at any price below this in the long run. As a result the long run supply curve will be the marginal cost curve above average total cost.A supply curve can only be derived from the marginal cost curve for firms operating in perfectly competitive markets. The concept of a 'supply curve' is inappropriate when dealing with monopoly situations because a monopoly is a price-maker, not a "passive" price-taker, and can thus select the price and output combination on the demand curve so as to maximise profits where marginal revenue = marginal cost.Author: Geoff Riley, Eton College, September 2006

Explain the role of commercial banks in the economic development of a country?

What is the Iimportance of Bank in the Economy?The role of banks in an economyWe all think we know what a bank is and what it does. And not without reason:most people have had experience of at least one bank, even if it is only throughhaving a salary account or withdrawing cash from an ATM.My aim in talking to you today about the role of banks in an economy is not tolecture you from high on banking theory. Although my goal is simple, it appearsalmost unattainable: to promote a slightly better understanding of what a bankcan do and what a bank should do. Before this question can be answered, we needto look at what banks actually do and how they do it. Here we are not in theexclusive domain of bank employees and specialists. As we have seen over recentmonths, these matters can affect ordinary citizens and voters very quickly.At several stages before, during and after the campaign on the part of the federalgovernment, cantonal authorities and business community to save Switzerland'snational airline, the feeling was very much one of "it's up to the banks to dosomething". In letters to the press and in some articles, a great number ofcontradictory, confused and in many cases unrealistic hopes, accusations andexpectations were laid at the banks' door. For example, the banks were criticised fornot stopping to recommend Swissair bonds to investors long before the crisisbroke, but at the same time they were pilloried for failing to grant far more creditto Swissair during the crisis. Contradictory reactions such as these areunderstandable up to a point. They are a measure of the shock, uncertainty andhelplessness experienced by many people in Switzerland, and not just the averageman in the street. As understandable as these reactions were from thepsychological perspective, however, they proved to be extremely unhelpful inpractice. Any "Bank of Joe Public" that would have attempted, even for a moment,to satisfy the expectations held of it would not only have failed to save the airline;it would most probably have faced bankruptcy itself, destroying its clients' deposits,employees' jobs and owners' capital in the process.Banks are widely held to be powerful and rich. This view is generally based on thevery accurate observation that banks deal with vast amounts of money. A quicklook at a bank's balance sheet quickly puts this perception into perspective: incontrast to industrial companies, more than 90% of a bank's balance sheet consistsof loans and deposits; the proportion of tangible assets such as buildings,machinery, etc. is minimal. What is generally most striking in a bank's balancesheet, however, is that the (unweighted) portion of equity rarely exceeds 5%. Theproportion of borrowings is far higher. This is, of course, in the nature of thebusiness: banking means working with and managing outside capital entrusted toa bank by, for example, people like yourselves, the companies you work for or yourpension fund. Unlike the people who actually own this capital, banks have verylimited powers when it comes to deciding what should be done with the money.Regardless of how individual aspects are structured, a bank's business policy willalways have to be geared in equal part to the clients of that bank and its owners.Clients choose a bank because they trust it not to lose their money and becausethey expect a specific level of value added and are willing to pay fees andcommissions in return. The same applies to the owner who makes his or her capitalavailable to the bank, thereby taking on certain risks and expecting to benefit frompart of the profit.A bank's activities in all its divisions can basically be simplified as follows: ittransfers money and information, and in doing so transforms money, maturitiesand risks. In the rest of my speech, I intend to use the example of four lines of abank's business to examine how it does this, the value added it creates, the risks itencounters and the restrictions to which it is subject: (1) lending and depositbusiness, (2) securities issuing, (3) asset management and (4) foreign exchangetrading.Lending and deposit businessA bank's role as an "intermediary" is clearest in the credit and deposit business.Clients "bring" to the bank their savings, i.e. the money they have chosen not tospend. The bank transfers this money to its credit clients in the form of loans. Whatis on the face of it extremely simple is nevertheless fraught with a great many risks.A bank's loans lack liquidity, either partially or totally. This means that the bankcannot sell them in return for demand deposits or central bank funds whenever itlikes. On top of this, a borrower's credit rating may change during the life of a loan,thereby changing the value of the loan at that point in time, which reflects theinterest and amortisation payments expected in the future. Due to the lack of asecondary market, credits are mostly carried in balance sheets at their nominalvalue, with provisions and write-offs only being formed or effected if there are anyindications that the borrower may have trouble meeting payments or is actually inarrears. In some cases, credits may even become entirely worthless if borrowersbecome insolvent and bankrupt.On the other side of the balance sheet, a bank guarantees its creditors the nominalvalue of their deposits plus interest due, irrespective of the profit or otherwisemade in lending transactions. Furthermore, the amounts a bank owes are generallymore liquid than the amounts it is owed; in other words, creditors can call in theamounts the bank owes them more quickly than the bank can call in what is due toit from its borrowers. One of the banks' fundamental roles in the economy is to"transform" maturities in this way at its own risk. This is part of the service it offersas intermediary and a form of risk management.Another function which the banks perform within an economy is rating andselecting the loans they finance. The supply of client deposits is limited; thedemand for credit generally less so. This being the case, credits have to be subjectto a selection process. The reason why this selection process cannot be performedsolely via the price (or rate of interest) is that lending transactions are not the sameas cash transactions, where payment is provided immediately upon a product orservice being rendered. Instead, the borrower undertakes to make future paymentsof interest and principal. As a consequence, the bank cannot base itself solely onthe ability to pay as presented at that particular point in time; it also has toattempt to make some sort of assessment with regard to the borrower's ability topay in the future.Through their activities as "agent", another essential function performed by thebanks is to reduce risks overall. A bank that uses deposits from a large number ofprivate households to finance loans to a large number of companies is leveragingthe advantages of diversification. Insofar as depositors take the decision towithdraw their funds independently of one another, the bank benefits from theLaw of Large Numbers , given that it is not anticipating a situation where alldepositors withdraw their savings at the same time. Diversification places a role inthe lending business, too, this time over a large number of companies and sectors:a proportion of individual risks is evened out on aggregate and the bank functionsin much the same way as an insurance company.As financial intermediaries, banks have a responsibility towards both theirborrowers and creditors. Their prime responsibility is that towards their creditors(Implementing Ordinance on Banks and Savings Banks, 1998; Swiss Federal Law onBanks and Savings Banks, Article 4.). Together with protecting the function andreputation of the banks, the main aim of the law on banks and savings banks is toprotect creditors. The Federal Banking Commission's regulatory and supervisoryactivities are all geared primarily to this aim.There is no similar protection under public law for those who have been lent moneyby a bank. The rights of such borrowers are covered in particular by the privatecontract which they have entered into with the bank. Within such contracts, banksgenerally undertake to provide specific products or services. They also contract tofulfil their due diligence and fiduciary responsibilities towards their borrowers.There is no legal obligation upon a bank to grant a loan to its clients under certaincircumstances. Indeed, the banks could not possibly be subject to such an"obligation to contract", and for an obvious reason: it would be diametricallyopposed to the aim of protecting creditors. This said, there have been and there arestill banks which function mainly upon the principle of providing cheap loans orallowing co-operative structures to become self-sufficient in loan provision. Someexamples of this are the Swiss cantonal banks founded in the 19th century, theRaiffeisen banks and community development banking in the United States.Securities issuingLoans account for only part of the long-term financing provided by the banks.While bank loans are often the only source of outside financing for many small andmedium-sized enterprises, a substantial proportion of the capital raised by largercompanies comes from the issuing of securities. This is also reflected in overall assetstructures: banks hold around CHF 1,100 billion in bonds in their clients' portfolios,compared to the client deposits of CHF 900 billion carried in the banks' balancesheets.In a securities issue, a bank or group of banks generally agrees to underwrite theentire amount of the issue. The securities acquired in this way are then offered forpublic subscription for the account and at the risk of the bank or banks involved.The risk that not all the securities will be placed with clients is carried by the bank.The issuer, for its part, has immediately available to it the entire proceeds from thetransaction, regardless of how successful the offering has been. For a bank to besuccessful with an offering, it has to be able to gauge market conditions correctlyat the time of the issue and has to have access to as broad a base of custodyaccount clients as possible, in order to place the securities with these clients.Securities issues are a volatile source of earnings, as we have seen over recentmonths with IPOs in particular. They can be lucrative, especially if they do not onlyinvolve the simple issuing of fixed-income paper but are structured around morecomplex transactions in several currencies with the aim of, for example, financingan acquisition. In transactions such as these, the in-depth analysis and specialistknowledge a bank provides are critical.The universal banks active in the issuing sector face a whole range of potentialconflicts of interest, given that issues often involve various parties from within andoutside the bank and that these parties are not motivated by the same interests:the issuance unit is interested in the offering, securities trading is looking for highrevenues, asset management clients expect the bank to safeguard their interestsirrespective of its role in the issuing transaction, the lending unit may haveinformation on the issuer that is otherwise not in the public domain, etc. Defusingand controlling potential conflicts such as these places enormous demands on abank's organisational structure, processes and compliance activities. Only when abank succeeds in controlling the potential conflicts and managing them on atransparent basis can the different stakeholders involved be sure that theirlegitimate interests are equitably upheld.Asset managementAsset management covers a range of banking activities: portfolio management,investment advisory, securities trading and lending business (collateral loans,securities lending and borrowing). With a discretionary portfolio managementagreement, clients authorise a bank to undertake, for their account and at theirrisk, all the actions it deems appropriate within the framework of the normal assetmanagement activities of a bank. Clients expect their assets to be managedprofessionally and in their best interests. The bank contracts to exercise itsundertaking to the best of its knowledge and abilities, taking into account clients'circumstances but acting as it sees fit within the scope outlined as part of theinvestment goals defined with the client.What is clear from this is that the singularly most important factor in assetmanagement, independently of any law or regulation, is the trust a client has in hisor her bank. Our Association's Portfolio Management Guidelines form part of theregulations which a bank must observe. These guidelines specify that a bank whichaccepts portfolio management agreements must have appropriate professionalorganisational structures which are commensurate with the activities involved, thatconcentrations of risk must be avoided, that, where there are no instructions to thecontrary, the bank must invest in securities for which there is a ready market, etc.The asset management business places exacting requirements on banks andbankers in terms of the expertise and ethical issues involved. Under nocircumstances can a bank simply "do as it pleases" in the portfolios it manages forclients, nor should it be allowed to do so.Foreign exchange tradingThe last business I mentioned was foreign exchange trading, an activity which hasbeen unjustly attacked as "casino capitalism". Various factors have given rise to thisperception. First, without a doubt the massive amounts traded in the foreignexchange markets every day. According to figures from the Swiss National Bank, forexample, in April 2001 foreign exchange trades in Switzerland alone amounted toCHF 121 billion each working day. (For the purposes of comparison, the globalfigure was USD 1,210 billion.) The vast majority of this trading takes place betweenfinancial intermediaries, the aim being to exploit even the slightest differencesbetween exchange rates (arbitrage). Only a very small proportion of these trades isused to finance foreign trade and hedge foreign currency positions. Furthermore,the fact that serious economic crises such as the one Argentina is experiencing atpresent are almost always currency crises may fuel suspicions that it is currencytraders with their speculative attacks that trigger such developments.In fact, the very opposite is true. Many people may fail to see the point of the vastamounts of arbitrage transactions, since they are not primarily used for financingpurposes. In reality, however, they underpin liquidity in the markets, thus helpingthem to function smoothly. In less liquid markets, new information wouldinevitably lead to much greater volatility in rates. A distinction has to be made inthe case of protracted currency over- or undervaluations (in terms of interest ratesand purchasing power parity), which are a genuine problem, as they could result inthe misallocation of resources.The scope available to banksBut what is the actual function of a bank within an economy? By granting loans,processing payments, accepting deposits, carrying out investments, etc. it iscreating added value for its clients, employees, service providers and shareholders.In this, it is no different from any other company. The real difference lies in theextent of the potential damage were a bank to collapse: Then it would not only beemployees losing their jobs, shareholders losing their capital and clients theirprovider; clients could potentially lose their entire savings and financial assets. Thisexplains why banks are so heavily regulated and so strictly monitored.Nevertheless, the economic benefits generated by a bank are basically no differentfrom the economic benefits generated by a doctor, teacher or train driver: byexercising, to the best of their knowledge and abilities, their specialist function incompetition with others, companies and their employees make their contributionto economic benefit. And their motivation need not be a selfless one. Pilots do notfly planes to generate economic benefit, just as bankers do not grant credits forany such selfless reasons. Economic utility is created as a "by-product" anywherewomen and men function successfully, and this does not apply solely to their jobs.Even though a banker grants loans to many companies and sectors of theeconomy, this does not mean he can do their work or bear their responsibilities.The argument of economic goals and responsibility is generally seized on bypoliticians when it is a matter of re-distributing capital, risks, profits or costs.Although not strictly wrong, the economic responsibility argument has the majorpolitical advantage that it can be flexibly deployed for absolutely anything. You willlook long and hard - and probably in vain - for any "handy" definition of a bank'seconomic responsibility that is at the same time general enough. Which is why mysuggestion is the following: bankers act responsibly when they ensure that theirhouse is in order and resist the temptation to pass off poor financial performanceas a contribution to the economy.

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