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Agency Theory Or Principal Agent Theory

704 words - 3 pages

Agency Theory or Principal Agent Theory is the relationship that involved the contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals will engage the agent to carry out some services on their behalf and would normally delegate some decision-making authority to the agents. However, as the number of shareholders and the complexity of operations grew, the agent, who had the expertise and essential knowledge to operate the business and company tend to increasingly gained effective control and put them in a position where they were prone to pursue their own interests instead of shareholder’s ...view middle of the document...

The effort problem thus, needs to be foreseen by the principal in contracting the agent to perform and manage their organizations.
The second problem or issues is the use of assets problem concerned the insiders who capable of controlling corporate assets. They might abuse these assets for purposes that are harmful to the interests of shareholders like diverting corporate assets, claiming excessive salaries and manipulating transfer prices of assets with other entities they have power over.
The third problem is different risk preferences. This problem arises because the principal and agents have different views on risk taking. Agents may not act in the best interest of shareholders and may have different interests and risks preferences for themselves. For example, agent have a wider range of economic and psychological needs such as to maximize compensation, security, status and to boost their own reputation, which may be adversely affected by a project that increases a firm’s total risk or has rewards in the longer-term. This may result in managers being too cautious in making investments and thus failing to maximize shareholders wealth (Azmi, 2011).

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