February 2012: Financial Innovation, Complexity, and Agency Theory

The last few years of financial turmoil have made the job investors – from trustees and financial officers of institutional funds and endowments to retail investors – more difficult than ever before, in part because of the complexity and fragility of innovative financial instruments, and the sometimes imperfect relationship between investors and their advisors and fund managers.

In the year leading up to the crisis, the market offered investors highly leveraged and often opaque instruments to major institutional players as risk mitigating, yield generating instruments, even as some of them came to recognize internally the instruments were dangerous and unsustainable. The ultimate reason for this unfolding debacle, wrote Paul Krugman, was “’financial innovation’ – two words that should from now on strike fear into investors’ hearts.”

Despite this recent history, the passion for inventing and marketing financially innovative tools has continued without pause. Today investors are still routinely presented with an assortment of complex and exotic instruments as the solution to their problems of return.

How can we address investors ability to navigate the range of complex products? We believe this is a key topic as part of our comprehensive series on the theory and practice of responsible investment.

This convening was held on February 17, 2012.

Read a summary of the convening here.

Relevant Articles

“‘Death Derivatives Wall Street’s Latest Bet.” Bloomberg News. May 17, 2011. pdf

Eisenhardt, Kathleen M. “Agency Theory: An Assessment and Review.” Academy of Management Review (1989) vol. 14 no. 1, 57-74.

Krugman, Paul. “Innovating Our Way to Financial Crisis.” New York Times. December 3, 2007. pdf

SEC v. Citigroup Global Markets, 2nd U.S. Circuit Court of Appeals, No. 11-5227 (2011). pdf