...Agency Theory: A brief Review by N. Waweru The agency theory assumes that there exists a contractual relationship between members of a firm. It recognises the existence of two groups of people; principals or superiors and agents or subordinates. The principals will delegate decision making authority to the agents and expect them to perform certain functions in return for a reward. Both the principals and the agents are assumed to be rational economic persons motivated solely by self-interest but may differ with respect to preferences, beliefs and information (Jensen and Meckling, 1976). The principal/agent relationship can exist throughout any organisation and usually starts from the shareholder-director and ends with the supervisor-shop floor worker (Figure 1.1). In an organisation context, which involves uncertainty and asymmetric information, the agent’s actions may not always be directed to the best interests of the principal. Agents’ pursuit of their self-interest instead of those of the principal is what is called the agency problem (Jensen and Meckling, 1976). To counter this behaviour, the principal may monitor the agents’ performance through an accounting information system. The owner can also limit such aberrant behaviour by incurring auditing, accounting and monitoring costs and by establishing, also at a cost, an appropriate incentive scheme (Jensen and Meckling, 1976). According to Jensen (1998), agency theory seeks to understand: (1) how to assign decision making...
Words: 1400 - Pages: 6
...Business Finance Bounded it is an idea that in making a choice, rationality of person(s) is restricted to the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. It was suggested by Herbert A. Simon as an alternative basis for the mathematical idea of decision making, as used in economics and related disciplines; it adds up rationality as optimization, which views decision-making as a fully rational sequence of finding an absolute choice given the information available. Thus the decision-maker is a satisfier, one seeking a satisfactory solution rather than the optimal one. Simon used the analogy of a pair of scissors, where one blade is the "cognitive limitations" of actual beings and the other the "structures of the environment"; minds with limited cognitive resources can in this way be successful by exploiting pre-existing structure and regularity in the environment. Opportunism: is defined as a egoist interest seeking with guile and as the active tendency of the human agent to take advantage in any circumstances, of all available means to further his personal privileges’ (couzier, 1964, pg.265 e.g. biological opportunism, used as a neutral scientific description), it may also be defined more neutrally as putting self-interest before other interests when there is an opportunity to do so, or flexibly adapting to changing circumstances to maximize self-interest (though usually in a way that negates some...
Words: 472 - Pages: 2
...Agency theory is controversial and essential theory in accounting, economic and finance sphere. The theory raises a problem of agency relationship, in which, cooperating parties- principal and agent, have different goals and division of work. Agency theory arises two problems: the difficulty of verifying what the agent is actually doing, and the conflict between goals and desires of the principal and agent (Eisenhardt, 1989). Agency theory is based on two different approaches: positivist agency theory and the principal-agent research. The first one describes the governance mechanism that limits the selfish behavior of the agent. Positivist agency theory identifies two propositions including governance system. If the contract between the principal and the agent is based on outcomes, there is a high probability that the agent will act in the interest of the principal. In addition if the principal has information to verify behavior of the agent, then the agent will act in the interest of the principal. The second one, principal-agent stream, contains more testable implications than the positivist theory. There are several things like goal conflict, easily measurable outcome, and the assumption that the agent is more risk averse than the principal, that are assumed in principal-agent research. The main difference between these two theories is that the positivist agency theory identifies certain contract alternatives and principal-agent theory indicates which contracts are the...
Words: 324 - Pages: 2
...Agency Theory Agency theory identifies the agency relationship where one party, the principal, delegates work to another party, the agent who performs that work. In the context of corporation, the agents are the managers and the principals are the shareholders. Agency theory as related to the corporation is set in the context of the separation of ownership and control as described in the work of Berle and Means (1932) Agency relationship Agency relationship is defined by Jensen & Meckling (1976) as a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizes there is good reason to believe that the agent will not always act in the best interests of the principal. Agency cost Agency cost is the principal can limit divergences from his interest by establishing appropriate incentives for the agent and by incurring monitoring costs designed to limit the aberrant activities of the agent. In addition, in some situations it will pay the agent to expand resources to guarantee that he will not take certain actions which would harm the principal or to ensure that the principal will be compensated if he does take such actions. However, it is generally impossible for the principal or the agent at zero cost to ensure that the principal will be make optimal decisions from the principal’s...
Words: 1211 - Pages: 5
...Agency Theory Extract from "Pierre Vernimmen, Corporate Finance: Theory & Practice" John Wiley & Sons. (p 639-641, 992) Agency problems occur in a company when ownership is separated from management. Managers may be tempted to achieve their own objectives instead of the financial objective. We explore these problems in the discussion which follows. Agency theory says that a company is not a single, unified entity. It calls into question the claim that all of the stakeholders in the company (shareholders, managers and creditors) have a single goal – value creation. Agency theory shows how, on the contrary, their interests may differ and some decisions (related to borrowing, for example) or how products (stock options) come out of attempts to achieve convergence between the interests of managers and shareholders to protect creditors. It analyses the consequences of certain financial decisions in terms of risk, profitability and, more generally, the interests of the various parties. Agency theory is the intellectual basis of corporate governance. Agency theory says that a company is not a single, unified entity. It considers a company to be a legal arrangement that is the culmination of a complex process in which the conflicting objectives of individuals, some of whom may represent other organisations, are resolved by means of a set of contractual relationships. On this basis, a company’s behaviour can be compared to that of a market, insofar...
Words: 1102 - Pages: 5
...Agency Theory The agency theory looks at the problems that can arise in a business relationship when one person delegates decision-making authority to another. Typically the person that is delegating decision-making is considered the principal, and those that are delegated to are the agents. A principal is someone who is above another person, a manager, supervisor or president of a company. Agents are any people that are below another person and is told to make decisions on behalf of the company. Issues can arise in these settings when the agents choose to make decisions that are not beneficial to the company or that are beneficial only to them. A real life example of agency-principal relationships and how they can affect someone is a relator’s office. A realtor can easily exert an effort to increase their monthly rent r absolute sale price for a property they are responsible for. However, most realtors don’t feel it isn’t worth their time to try to increase these prices because they only receive a fraction of the price of the sale/rental in commission. They feel this way even if the total value to the owner of the property is enough to make it worth it in absolute terms. This isn’t the only example of how agency theory is applicable in the real world, the insurance industry use this theory as well. Say you have full coverage on your vehicle and this covers all repairs that are at no-fault to you as the owner of the vehicle. Say now, that there is a crack in your windshield...
Words: 421 - Pages: 2
...hubungan keagenan sebagai: “Agency relationship as a contract under which one or more person (the principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent.” Maksud dari kutipan dalam teori keagenan Jensen dan Meckling diatas bahwa pemegang saham (shareholders) sebagai prinsipal dan manajemen sebagai agen. Manajemen disini adalah pihak yang dikontrak oleh pemegang saham untuk bekerja demi kepentingan pemegang saham. Oleh karena itu, maka pihak manejemen harus mempertanggung jawabkan semua pekerjaannya kepada pemegang saham. Dalam teori agensi, hubungan keagenan merupakan suatu kontrak dimana satu atau lebih orang (prinsipal) memerintah orang lain (agen) untuk melakukan suatu jasa atas nama prinsipal serta memberi wewenang kepada agen untuk membuat keputusan yang terbaik bagi prinsipal. Jika kedua belah pihak tersebut mempunyai tujuan yang sama untuk memaksimumkan nilai perusahaan, maka diyakini agen akan bertindak dengan cara yang sesuai dengan kepentingan prinsipal. Namun dalam hubungan keagenan ini tak jarang terjadi perbedaan pendapat atau konflik. Konflik hubungan antara prinsipal dan agen salah satunya dapat timbul karena adanya kelebihan aliran kas (excess cash flow). Kelebihan arus kas terjadi karena adanya kejadian – kejadian yang tidak ada kaitannya dengan kegiatan utama perusahaan. Hal ini yang lantas disebut sebagai Agency Cost. Agency Cost ini...
Words: 20426 - Pages: 82
...Journal of Financial Economics 3 (1976) 305-360. Q North-Holland Publishing Company THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE Michael C. JENSEN and William H. MECKLING* University of Rochester, Rochester, NY 14627, U.S.A. Received January 1976, revised version received July 1976 This paper integrates elements from the theory of agency. the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optirnality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing tht- creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem. The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frcqucntly watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give thcmsclvcs a dispensation from...
Words: 27266 - Pages: 110
...Links between Ghoshal's article, Agency Theory and the 2008 Global Recession. We are all too familiar with the mayhem caused by the global financial crisis; we are still recovering from the after effects of this mayhem. In this essay I will try to investigate the relationships between the Agency theory, Ghoshal’s article on how bad management theories are destroying good management practices and the Global Financial Crisis of 2008. I will start off by introducing the Agency theory and looking at some of its pros and cons, then I will go on to relate the theory to the causes of the global financial crisis of 2008 and finally show how some of the actions based on the Agency theory could have been the foundations of the meltdown. I will then talk about how Ghoshal, in his article, talks about the complete amoral education and scientific measurement methods of the new age management schools which are fueling an ever increasing mistrust between the stakeholders and management. “Agency Theory concerns how two parties in a contractual relationship may interact depending on their attitude towards risks and whether their individual goals align” (Jon Tan, 2009). The agency theory sees two problems that can occur in an agency relationship where one party (stakeholder) delegates work to the agent. The first problem arises when the desired goals of the principal (stakeholder) are not aligned with those of the agent and it is difficult or expensive for the principal to verify what the...
Words: 2842 - Pages: 12
...BASIC IDEAS OF AGENCY THEORY (Gray & Manson, 2007) suggest that the basic ideas of the agency theory should include the following; * Both owners who are the principals and the managers who are the agents are deemed to be wealth maximizing agents * Individuals falling into different groups will ideally have different information and thus the more informed individuals will make a profit at the expense of the others * Another critical assumption made by agency theory is that for the owners to believe the report prepared by the managers of the business, they will demand to have this report verified by a third independent party. * Agency theory goes on to suggest that the appointment of professional external auditors is the most preferred cost effective way of monitoring the agents. * Under strict agency theory, financial reports are thus regarded as reports to owners of the business who are the principals and the external auditor is seen to act for and on behalf of the owners. DEFINITION OF AUDIT STATEMENT OF AUDITING STANDARDS-GLOSSARY OF TERMS issued by the Auditing Practices Board defines an Audit as; “ An exercise whose objective is to enable auditors to express an opinion whether the financial statements give a true and fair view of the entity`s affairs at the end of a period and its profit or loss for the period then ended and have been properly prepared in accordance with the applicable reporting framework” PARTIES TO THE AUDIT PROCES The...
Words: 962 - Pages: 4
...Tranfer Pricing and Agency Theory Performance management: It is composed by objectives, that are achieved through programs, that are supported by technologies. There are different to objectives to achieve in single departments and areas: 1. Cost reduction 2. Quality improvement 3. Capacity improvement Since there are a lot of objectives, we say that performance management is discursive. To manage the achievement of meeting these obj there are different programs: 1. Lean production (for cost reduction) 2. Total Quality Management, Manufacturing Excellence (for quality improvement) 3. Demand Chain Planning (capacity improvement) Since all the objectives can be reached with different programs, we say that performance management is programmatic. Management technologies = managing accounting techniques. There are different costing systems/technologies implemented to support the programs: 1. Target costing, Activity Based Costing, Kaizen Costing 2. 6sigma 3. S&OP Process We thus say that performance management is also technological. Accounting numbers foster control at a distance. Everything becomes a number in the accounting report: we reduce the complexity of a real world in a 3D form into some 2D accounting reports. These 2D reports lead to “amplification”, caused by the fact that: * reports are mobile/transportable * reports are combinable between each other in order to provide a more complete picture of the reality * numbers make everything manageable. How...
Words: 2784 - Pages: 12
...should take into account in the human service field. It is important to execute procedures and protocols that address consumers without social partiality in social systems. Contained in this paper, the reader has a impression of how a dream organization or agencies arrange quality service delivery to their consumers. The expression empowerment connects to the English word power. Empowerment permits organizations, agencies, and selected individuals the authority to act for a precise aspiration or purpose (Rapport, 1987). Principles and Empowerment Approach Social service management consists of 12 basic principles that assist human service professional in supporting their clients through the application of the empowerment approach. The essayist will attempt to provide a summary and a concise account of how these approaches affect organizational structuring. First, an effective organization works diligently at designing a structured agency that offers support, provide resources, and encourage client participation. When coordinated processes are in place for consumers, the organization is allowing the consumer the chance to be a part of the decision- making process. Many agencies still introduce and utilize the classical theories approach. However, there is an enduring apprehension that these professionals are only carrying out tasks that he or she is comfortable with instead of what better meets the needs of the client according to Perrow (1986). When granted the chance consumers...
Words: 1282 - Pages: 6
...Consumer Culture Theory, Consumer Agency and the Importance of Brands Summary of the Importance and Relevance of Topic Consumer Culture Theory (CCT) refers to the classification of a certain approach to studying consumers and the way that they consume. It was first coined in 2005 by Arnould and Thompson, and it specifically addresses the sociocultural, symbolic, experiential and ideological facets of consumption. Their work is the culmination of over a quarter century of research that treats consumer behaviour as a phenomenon worth studying. As we have come to develop the field of CCT, so too are we developing our understanding of the consumer, and the broader economy. The work of Arnould and Thompson has provided students of consumer behaviour with the necessary environment to debate, innovate and advance the field of study.1 CCT is important within the scope of consumer behaviour because it places a focus on meaning and identity creation; it delves deeper in the mentality that surrounds consumers in the marketplace, and an understanding of this mentality is useful to all that engage the market (buyers, sellers, producers, etc...). “CCT explores how consumers actively rework and transform symbolic meanings encodes in ads, brands, retail settings, or material goods to manifest their particular personal and social circumstances and lifestyle goals.”2 In understanding CCT, we understand the market in a broad sense, for example, acknowledging that marketing symbols are significant...
Words: 3745 - Pages: 15
...Work is no longer a domestic relationship and we also saw that master as employer have great control their servant/employees in their work performance. Control becomes an important key to determine if a person is an employee as of today or to show if there is an employment relationship. There are differences between employees and independent contractors, an independent contractor is a person who agrees to deliver a certain outcome whereas an employee, who must obey instructions from his or her employer in the discharge of his duties, so independent contractor act independently from the principal that hires him.The independent contractor can delegate others to complete the job as the principal is not concerned with how the contractor does it, so long the outcome is achieved. Using control test from the common law, we can determine that Amanda is an employee of the company as the company control her working hours. We are concerned with the nature of the control and the degree of the control – Federal Commissioner of Taxation V J Walter Thompson (Aust) Pty Ltd (1994) Case. In Walter Thompson case, the company hired artists to perform radio plays for advertisements. The High court of Australia found that the producer controlled the actors during rehearsals and performance and held that there is an employment relationship here. Thus , we can use this case to prove that Amanda is an employee of the company. We can use the multi factor test to determine whether Amanda is the...
Words: 1163 - Pages: 5
...When thinking critically about Benjamin Franklin’s view on the poor laws, it became apparent that his views were connected to the views of a conservative. Benjamin Franklin believed that “the best way of doing good to the poor is not making them easy in poverty, but leading or driving them out of it” (Williams, H.,1994). Analyzing Benjamin’s meaning behind this statement is thought provoking; from a conservative point of view this statement can be perceived as individuals needing to take care of them selfs without any help from social services or government agencies. Benjamin Franklin believed that all individuals should be solely responsible for themselves and their economic welfare even if they were to become disabled or elderly, the belief was that they should have prepared for the unknown (Williams, H., 1994). Franklin took the stance that the poor laws made individuals dependent on others to provide for them, which then would lead to increased poverty and reliance on government supports. Franklin argued that the less you provide for individuals forces the individual to do for themselves, promoting independence, self worth and riches. Although Franklin believed that getting assistance form private charities could be harmful; he also believed that if the government was able to delegate how the programs were managed then this would prove to be 1 more effective (Williams, H., g82). The view that the government would be able to police the programs to ensure that individuals...
Words: 351 - Pages: 2
