Agency Theory is defined the branch of financial economics that looks at conflicts of interest between people with different interests in the same assets. This most importantly means the conflicts between: * shareholders and managers of companies.
* shareholders and bond holders.
Agency theory is rarely, if ever, of direct relevance to portfolio investment decisions. It is used to by financial economists to model very important aspects of how capital markets function. However, investors gain a better understanding of markets by being aware of the insights of agency theory. The cause:
* They have voting rights in general meetings
* Equity investors are deemed to be the owners of the company * In case of profit, they may receive dividend after tax
CONFLICTS BETWEEN MANAGERS AND Shareholder:
1. SELF-INTERESTED BEHAVIOR.
Agency theory suggests that, in imperfect labor and capital markets, managers will seek to maximize their own utility at the expense of corporate shareholders. Agents have the ability to operate in their own self-interest rather than in the best interests of the firm because of asymmetric information and uncertainty (e.g., myriad factors contribute to final outcomes, and it may not be evident whether the agent directly caused a given outcome, positive or negative). Evidence of self-interested managerial behavior includes the consumption of some corporate resources in the form of perquisites and the avoidance of optimal risk positions, whereby risk-averse managers bypass profitable opportunities in which the firm's shareholders would prefer they invest. 2. COSTS OF SHAREHOLDER-MANAGEMENT CONFLICT.
Agency costs are defined as those costs borne by shareholders to encourage managers to maximize shareholder wealth rather than behave in their own self-interests. The notion of agency costs is perhaps most associated with a seminal 1976 Journal of Finance paper by Michael...