Agency Theory

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Agency Theory

Agency theory is widely used in different companies, businesses and organizations Agency Theory is basically about the association between the boss, which is the Principal, and the worker, which is the Agent. A good example for an application of the Agency Theory would be sharecropping, where the Principal is the landowner and the Agent is the farmer. Another example for the Agency Theory in a more familiar organizational structure would be the relationship between a company’s shareholders, which is the Principal, and the company’s CEO, which is the Agent.

As seen from the table below, Agency Theory clearly deals with the relationship between the Principal and the Agent. The table explains the important elements that affect the relationship between the Principal and the Agent. The elements involve the contract, self-interest, risk-bearing cost, risk preferences, etc. between the principal and the agent.

Theory element| Description|
Key idea| Principal-agent relationships should reflect efficient organization of information and risk-bearing costs| Unit of analysis| Contract between principal and agent|
Human assumptions| Self-interest, Bounded rationality, Risk aversion| Organizational assumptions| Partial goal conflict among participants, Efficiency as the effectiveness criterion, Information asymmetry between principal and agent| Information Assumption| Information as a purchasable commodity| Contracting problem| Agency (moral hazard and adverse selection),Risk sharing| Problem domain| Relationships in which the principal and agent have partly differing goals and risk preferences (e.g. compensation, regulation, leadership, impression management, whistle blowing, vertical integration, transfer pricing)|

Source: Eisenhardt, M, K. (1989). Agency theory: An assessment and review. Academy of Management.the Academy of Management Review, 14(1), 57.

The essential idea on why the Principal-Agent theory is used is...
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