Top Importance of Agency Theory in Corporate Governance
What is an Agency Theory (Definition of a Agency Theory)
The agency theory is an assumption that explains the relationship between managers and agents in business.
Agency theory is used to understand the relationships between agents and principals. The agent represents the principal in a particular business transaction and is expected to represent the best interests of the principal without regard for self-interest
Importance of agency theory
By definition, the agent is using the resources of principle. The principal has interested money but has a litter or no daily input. The agent is known as a decision-maker, but it is incurring little risk because the principal will bear any losses.
In agency relationship, two parties exist, the agent and principal, whereby the former acts and takes decisions on behalf of the later.
In the finance, most talk about agency relationships exists between shareholders, executives of the corporation where top brass are elected to act in owners and actual companies.
The aim to represent the view of the owner and conduct operations in their interest. Agency relationships arise when one or more other individuals, called principal, called agents, perform some services, and then delegate decision-making authority.
When agency occurs, it also tends to raise agency costs, which are expensive to sustain an agency relationship, like ( offering management performance bonuses to encourage employees and managers in act the shareholders, interest).
Manager can be encouraged to act in the stockholders’ best interests through incentive, constrain, and punishment.
To reduce the moral hazard problem, stockholder incurs agency costs. Agency theory is an essential development in microeconomics past 20 years. It has application to accounting, industrial, organization, and labor economics, become the basis of the economic model of compensation.
Agency theory understanding of incentives provided to agents. The intensive is an issue because the agent needs not to have the same interest as the principal.
Agency theory focus on the cost of providing incentives. Like when you rent, an agency relationship is created. Even a car rental company is called an agency, it is most useful to look and the renter as the agent because it’s renter behavior that is an issue. A company like the agent to treat the car. The renter is contrast, knows it’s not her/his car, and often drives accordingly.
Owner and stakeholders in the company rely on managers and executives known as agents to see that their interest is served. Although some aspects of accounting theory touch on how to help clients and owners. It has a little common with agency theory.
Agency theory holds owners and shareholders to hire executives, managers, and agents to serve their interests. Agency theory says that there is always some conflict between the agent’s interest and those of her principal.
The agency approach thus refers to a theoretical and methodological approach to understanding social processes.
Agency theory attempts to explain and resolve a dispute over priorities between the owner and their agents.
Performance-based compensation on the way that is used to achieve a balance between principles and agents.
Principal rely on agents and execute certain transactions, mainly financial, resulting in a difference in agreement on priorities and methods.
For the agent to have the incentive to follow the principles directions. Agency theory also seeks to reduce costs in disagreements between both.