What is the agency theory in finance?
What is the agency theory in finance?
What Is Agency Theory? Agency theory is a principle that is used to explain and resolve issues in the relationship between business principals and their agents. Most commonly, that relationship is the one between shareholders, as principals, and company executives, as agents.
What is the main idea behind the agency theory?
Agency theory is an economic theory that views the firm as a set of contracts among self-interested individuals. An agency relationship is created when a person (the principal) authorizes another person (the agent) to act on his or her behalf.
What are the types of agency theory?
Two forms of agency theory have developed: positivist and principal-agent (Jensen, 1983). Positivist researchers have emphasized governance mechanisms primarily in large corporations.
What are the major criticism against agency theory?
Critics of agency theory have noticed as well that control mechanisms suggested on the basis of agency theory are not only expensive, but also economically ineffective, because mechanisms protecting shareholders’ interests may interfere with realization of strategic decisions, may restrict collective actions, distort …
What are the most important aspects of agency theory?
Agency theory says both principals and agents act in their own self-interest, which can work for their mutual benefit. Top management, for example, is motivated by high pay or corporate perks. To keep these things, they maximize the shareholders’ returns.
What is the difference between agency theory and stakeholder theory?
Key Takeaways. The agency theory looks to outline the interests of a principal and an agent, which can include an individual and a financial planner. The stakeholder theory suggests there are differences between individual groups within an organization, such as the employees, investors, and suppliers.
Why is agency theory important in business?
Agency theory is used to understand the relationships between agents and principals. The agent represents the principal in a particular business transaction and is expected to represent the best interests of the principal without regard for self-interest.
What are the two key assumptions in the agency theory?
There are two key assumptions underlying the agency theory, and they are: Individuals are generally egoists who act in their own self-interests. In short, both the principal and agent are out for their own benefits. Agents have access to more information and are usually in a decision-making capacity.
What are the 3 agency problems?
The three types of agency problems – stockholders vs. management, stockholders vs. bondholders/ creditors, and other stakeholders like employees, customers, community groups, etc.
What are the advantages of agency theory?
First, they offer executives incentives to take actions that will enhance shareholder wealth. Second, these plans help companies attract and retain managers who have the confidence to risk their financial future on their own abilities—which should lead to better performance.
What is the limitation of agency theory?
An agency problem may arise between managers and shareholders because the principals (the shareholders) cannot adequately monitor the actions taken by the agent (the managers). Subsequently, the agent can have an incentive to pursue their own interests, rather than the bet interests of the principal.
Why is stakeholder theory better than agency theory?
