Course: Foundations of Strategy and Organization (STMG555-13A)
Student Name: Nguyen Hoang Quan
University of Waikato
ID Number: 1206964
Summary of Agency Theory
The theory divides firms and other profit-oriented organizations into two subdivisions, namely principal and agent. Principal represents shareholders whilst agent characterizes managers, executives or other employees among a company. Basically, a principal delegates work to an agent with only one requirement of maximizing profit for the firm. However, each of the subdivisions has their own self-interest, different goals and therefore differentiates their attitudes toward risks they take in the company. Hence, there should be regulations and corporate control mechanisms in place with binding contracts to clarify principal’s interest while ensuring agent’s duties on a par with company’s strategic plans. Subsequently, both risk-taking parties will act with due care and diligence for the best interest of the firm. Reaction
According to Denis et al. (1999), there is a strong negative relation between executive’s ownership and diversification. The author takes the view that if executives own a significant part of company shares, they must have substantial power in the company’s decision making process. They therefore do not want to diversify their businesses, and firm’s investment portfolio will decline in terms of variety. What Denis et al. (1999) believe is that managers are relatively afraid of taking the risk by investing in too many different projects in lieu of focusing in a fewer fields to effectively use their capacity. Hence, managerial-ownership oriented companies tend to avoid threats by focusing in a smaller range of investments. However, I do not support this argument. I suppose that managers in the role of the main shareholders will be most afraid of how to control and minimize risks for the firm in prior to go beyond the break-even point. Thus, they...