Agency theory

Topics: Corporate governance, Board of directors, Audit Pages: 14 (5098 words) Published: May 30, 2015
Agency theory
Agency theory identifies the agency relationship where one party, the principal, delegates work to another party, the agent. In the context of a corporation, the owners are the principal and the directors are the agent. This model of corporate governance and subsequent research focused on resolving conflicts of interest between corporate management and shareholders (Jensen and Meckling, 1976) and has largely adopted an agency theory approach. Key assumption is that the principals and agents are anxious to maximise their own utilities at each others’ expense. As a result, there is almost always a divergence of objectives between the goals of the management and those of the shareholders. Governance seeks to reconcile the interests of principals and agents for the benefit of the company. The maximisation of shareholder wealth is assumed to be the company’s primary objective. One of the major causes for this agency problem is due to the information asymmetries which exist between the two parties. Information asymmetry exists because management are more closely involved in the business and for a longer time than the owners and thus have more information about the business than its owners individually (Aboody and Lev, 2000). A number of mechanisms have been devised to reduce agency problems and negate their impact on firms. There is a need to possess(拥有) incentive and monitoring mechanisms to ensure managers pursue shareholder wealth maximisation and the main focus of governance is the use and usefulness of incentive and monitoring mechanisms Incentive mechanism includes level and structure of remuneration and managerial ownership, and monitoring happened both internally and externally. Jensen and Meckling (1976) suggest that agency problems can be reduced by incurring agency costs, which consist of bonding costs and monitoring costs. Bonding costs are those which are incurred due to the contract between owners and management. Monitoring costs are the costs that are incurred during the course of implementing various governance mechanisms over agents.

An Overview of Stakeholder Theory
Stakeholder Theory emerged during the early 1970s when there was concern amongst society that large multinationals were becoming too powerful and therefore their accountability had to be extended to not just the shareholders but also other equally important stakeholders. Freeman and Reed (1983 p91) define stakeholders as “any identifiable group or individual who can affect the achievement of an organisation’s objectives, or is affected by the achievement of an organisations objectives”. Stakeholder can be divided into two groups. Primary stakeholders - one without whose continuing participation the corporation cannot survive as a going concern; Secondary stakeholders - those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival. Stakeholder theory broadly grounded in a range of different disciplines (i.e. not just economics based) and it contextualises the organisation as part of a broader social system and attempt to link governance with a wide range of stakeholders. Stakeholder theory has two main branches, the ethical branch and the managerial branch. The ethical branch of stakeholder theory states that all stakeholders have a right to be treated fairly by the organisation The managerial branch of this theory views the stakeholders’ economic power over the organisation as an indicator of how it is likely to be treated by managers (Guthrie, Petty and Yongvanich 2004).

An overview of Institutional Theory
Scott (2001, p54) views an institution as “a stable system of rules, either formal or informal, backed by surveillance and sanctioning power”. Organisational structures are "reflections of rationalised institutional rules" (Meyer and Rowan, 1977, p. 340), or "shared knowledge and belief systems" (Scott,...
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