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• Working Paper | 2015

  Customers and Investors: A Framework for Understanding Financial Institutions

  Robert C. Merton and Robert T. Thakor

  Financial institutions have both investors and customers. Investors, such as those who invest in stocks and bonds or private/public-sector guarantors of institutions, expect an appropriate risk-adjusted return in exchange for the financing and risk-bearing that they provide. Customers of a financial intermediary, in contrast, provide financing in exchange for a specific set of services, and do not want the fulfillment of these services to be contingent on the credit risk of the intermediary, even when they are not small, uninformed agents lacking in sophistication. This paper develops a framework that defines the roles of customers and investors in intermediaries, and uses the framework to provide an economic foundation for the aversion to intermediary credit risk on the part of its customers. It further explores the implications of this customer-investor nexus for a host of issues related to how contracts between financial intermediaries and their customers are structured and how risks are shared between them, as well as the consequences of (unexpected) deviations from the ex ante optimal contractual arrangement. We show that the optimality of insulating the customer from the credit risk of the intermediary explains various contractual arrangements, institutions, and regulatory practices observed in practice. Moreover, customers and investors are often intertwined in practice, and so this intertwining provides insights into the adoption of "too-big-to-fail" policies and bailouts by regulators in general. Finally, the approach taken here shows that financial crises may be a consequence of observed but unexpected deviations from the ex ante optimal risk-sharing arrangement between financial intermediaries and their customers.

  Keywords: Financial Institutions;

  Citation:

  Merton, Robert C., and Robert T. Thakor. "Customers and Investors: A Framework for Understanding Financial Institutions." NBER Working Paper Series, No. 21258, June 2015.  View Details

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• Article | Harvard Business Review | July–August 2014

  The Crisis in Retirement Planning

  Robert C. Merton

  Corporate America began to really take notice of the looming retirement crisis in the wake of the dot-com crash, when companies in major industries went bankrupt in large part because of their inability to meet their pension obligations. The result was an acceleration of America's shift away from employer-sponsored pension plans toward defined-contribution (DC) plans—epitomized by the ubiquitous 401(k)—which transfer the investment risk from the company to the employee. With that transfer has come a dangerous shift in investment focus, argues Nobel Laureate Robert C. Merton. Traditional pension plans were conceived and managed to provide members with a guaranteed income. And because that objective filtered right through the scheme, members thought of their benefits in those terms. Ask a member what her pension is worth and she'll reply with an income figure: "two-thirds of my final salary," for example. Most DC schemes, however, are designed and managed as investment accounts with the goal of accumulating the largest possible pot of savings. Communication with savers is framed entirely in terms of assets and returns. Ask a saver what his 401(k) is worth and you'll hear a cash amount and perhaps a lament to the value lost in the financial crisis. The trouble is that investment value and asset volatility are simply the wrong measures if your goal is to secure a particular future income. In this article, Merton explains a liability-driven investment strategy whose aim is to improve the probability of achieving a desired retirement income rather than to maximize the capital value of the savings.

  Citation:

  Merton, Robert C. "The Crisis in Retirement Planning." Harvard Business Review 92, nos. 7/8 (July–August 2014): 43–50.  View Details

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• Case | HBS Case Collection | October 2011 (Revised June 2013)

  Novo Nordisk: A Commitment to Sustainability

  Robert G. Eccles and Michael P. Krzus

  The case describes the early commitment of a European pharmaceutical company, Novo Nordisk, to integrated reporting. Novo Nordisk is one of the pioneers of integrated reporting and it emerged out of its commitment to a "Triple Bottom Line approach to managing the company." The case describes the company's "Blueprint for Change Programme" designed to facilitate stakeholder engagement and communicate how the company delivered value to business and society. The case also provides an investor perspective on the company's integrated reporting efforts and its plans for how to improve it in the future.

  Keywords: Strategic Planning; Business Ventures; Business or Company Management; Integrated Corporate Reporting; Business Strategy; Pharmaceutical Industry;

  Citation:

  Eccles, Robert G., and Michael P. Krzus. "Novo Nordisk: A Commitment to Sustainability." Harvard Business School Case 412-053, October 2011. (Revised June 2013.)  View Details

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