Agency and Granularity
Let me begin with the first problem. In a sparsely linked network, principals have to delegate decision making to other nodes, their agents, as well as share information with other nodes. Financial organizations are networks with central elements of authority, information, coordination, trust, responsibilities and rights, and processes for decision making. While these are standard elements of most organizations, financial networks have the unique feature of being intimately linked with other networks in the economic system and therefore have a comprehensive reach. A lapse in decision making or abrogation of responsibilities has repercussions beyond the organization itself.
This principal-agent problem is not new but increased connectivity has mitigated the problem by eliminating intermediaries, as we saw in Chap. 3. Formerly, an investor would select the fund manager, who selects firms, whose board members choose managers. At each link in this chain of transactions, there is the possibility of misallocation of resources. The investor, as principal, delegates management of retirement funds to the fund manager, as his agent. The contract between the two requires detailed information about the precise objectives ofthe investor and actions to take under various contingencies, such as a precipitous fall in the S&P500 Index. Implementation of this contract will require real-time coordination, stock market updates and a credible commitment to the specifications of the contract. Now imagine that this alignment of incentives and actions is required at the firm management level and then at the divisional level, and one can see the possibility of resources being depleted simply to monitor the process and set up an appropriate incentive structure.
With connectivity, new businesses leverage the tools of DCT to circumvent the inefficiencies and costs imposed by this agency problem - conflicts of interest between people who provide the resources and all the parties through which they travel. OR creates direct links between borrower and saver, and depositor and payments platform, thereby eliminating intermediaries. Granularity in the form of smaller companies is taking over individual business functions of financial institutions, along the lines of functionality: payments, agglomeration of resources, transfer of resources across time and space, risk management, and information revelation. “Fintech start-ups are nimble piranhas, each focusing on a small part of a bank’s business model to attack” .