Response of Distressed Firms to Incentives: Thrift Institution Performance Under the FSLIC Management Consignment Program

The Management Consignment Program (MCP) was adopted in 1985 by the Federal Savings and Loan Insurance Corporation (FSLIC) in an attempt to minimize the acute adverse incentive problems present when insolvent thrift institutions are allowed to continue in operation. The management of problem thrifts were replaced by new management teams, selected by federal regulators and compensated on a contract basis. They were expected to maintain service to depositors and improve the condition of the thrift's books and records while more permanent solutions were explored. Without close monitoring by the FSLIC, problem institutions with low or negative net worth would have an incentive to take on risky strategies which could further erode net worth. Under the MCP, given the new incentive structure, agency theory predicts that there would be no incentive to exert effort in other than a risk-averse way. However, in an attempt to preserve asset values, the new managers may lock in negative or inadequate profit margins, thereby precluding the possibility of a return to solvency by a successful (lucky) gamble for large profits. Therefore, although the MCP may have reduced total costs to the FSLIC, as a result of the absence of a profit motive and the conservative strategies followed, the chances of the MCP institutions recovering to solvency may have been significantly lowered when compared to similarly insolvent institutions that were allowed to operate outside of direct government control.