The knowledge of agency theory is fundamental for understanding how the agents and the principals relate. The agent is tasked with acting on behalf of the principal in a specific commercial transaction and as such expected to represent the interest of the principal with utmost good faith (Lashgari, 2014).However, the interests of the principals and the agents may result in a conflict of interest as some of the agents may not act perfectly as an ambassador of the principal’s interests. As a result of disagreement and miscommunication between the agent and the principal, various problems may arise within the company (Abdulla & Valentine, 2009). One of the major causes of inefficiencies and financial losses is the mismatch of desires between the stakeholders as a result of a wedge which leads to principal-agent conflict. The main cause of the principal-agent problem arises when the principal and agent interests conflict. Companies should strive to minimize agency problems through policies that are corporate (Lashgari, 2014). The agency theory provides a solid ground for understanding corporate governance as it elaborates conflicts that may arise as a result of a conflict of interest among various parties and the effective solutions to such conflicts.
Agency problem, on the other hand, refers to lack of trust between the agents and the principals. The agency relationship can be described as one that involves a contract between the principal and the agent where the agent represents the principal in matters of decision making since the authority has been delegated to the agent (Abdulla & Valentine, 2009). Since authority has been delegated, the decisions by the agent affect the welfare of both the agent and the principal. The agency model implies that the information asymmetries that exist between the agent and the principal results in principals lacking trust in their agents. The existence of bounded rationality, information asymmetries, and incomplete foresight makes it impossible for the principals to track and call for immediate action so that the agent may represent the interests of the principal.
Agency problems also referred to as principal-agent problems are inherent in corporate institutions that are static (Panda & Leepsa, 2017). The conflict takes the podium whenever the different stakeholders such as the principals and the shareholders take a different stance on their common interests. Business enterprises may utilize various dynamic techniques aimed at circumventing issues arising from agency problems for instance monitoring, contractual bonuses and relying on the help of third parties (Panda & Leepsa, 2017). Incentivizing employees has been proposed as one of the solutions by various scholars and corporate institutions. Agents who act to serve their interests can be reverted by transforming incentives to redirect these interests thus benefiting the principals. For instance, initializing incentives for meeting a certain sales quota may have a substantial effect as more salespeople will strive to reach goals set for the daily sales (Abdulla & Valentine, 2009). Contrary, if the only incentive available is hourly pay for the salespeople, then employees may have an incentive against the sales. Innovating and implementing incentives that support hard work on tasks benefiting the company encourage and motivate employees to support the interest of the business. Agency theory attempts to bridge the gap between the employers and employees through aligning the goals of the agent and the principal.
The shareholders ‘and managers’ conflict of interest results in agency costs. Shareholders have invested in a company through their finances and want their money maximized so that they can reap the profits accrued (Zarina & Yusof, 2016). Managers, on the other hand, are hired and control the daily operations of a company. The managers invest their human capital in a company, and they are obliged to maximize their efforts as well. If there is an alignment of interests for both the managers and the shareholders, then the agency problem gets eliminated. Companies are encouraged to offer incentive compensation to the executives as a motivation to encourage them to represent the interest of the shareholders. Thus, apart from the salaries and additional bonuses, managers are entitled to incentive payments that are tied to a company’s performance (Bonazzi, 2007). The incentive payments motivate executives to focus on the long-term performance of the company. There are two forms of incentive compensation, stock compensation, and grant that is stock-option. The new managers are offered a certain amount of stocks with good pricing which is a way of connecting their interests with those of the company.
Corporate governance is another effective strategy for dealing with the agency problems. Managers are tasked with the responsibility of running the affairs of a company (Davies, 2008). In an attempt to prevent the managers from deviation, the solution would be to monitor them looking at their activities to enable the shareholders to stop any improper decisions that may have serious repercussions to the company (Tricker, 2010). Governance in this context is exercised by the board of management regulate the executives based on the rules and regulations of a company (Namazi, 2013).
Some of the arguments against agency theory by ethicists is that it adopts action based on the economic model thus ignoring the fact rational people are individualistic or that people behave from an egoistic point of view forgetting their altruistic motives (Kultys, 2016). The ethicist’s point of view can be equated to moral skepticism and as such may not be a significant point of departure for developing a model of applied ethics. One response to such criticism is to state that economic model implies no such motives (Glinkowska & Kaczmarek, 2016). A utility is defined as individuals’ preference for various goods and services. Preferences reveal the desires of individuals as either egoistic or altruistic. It is thus evident that interests of the self-provide the platform for action and rational choice. Thus, the need for incentives in relationships that involve the principal and the agent is not the egoistic preferences that they possess but rather the different preferences they both have. The agency theory is about how people contain situations that entail goal incongruity among two or more parties. Selfishness or selflessness does not count but what counts is that each party pursues its own goals and the goals of the other party only matter if they hinder the agent from attaining its goals.
Some of the arguments in support for agency theory stems from the fact agency theory aims at identifying the conflicting points among the different parties (Glinkowska & Kaczmarek, 2016). Banks may want to reduce risk while shareholders rationally wish to maximize profits. Managers stand at a riskier point of view with regards to profit maximization since they are tasked with ensuring that there are profits (Kultys, 2016). The modern corporations are based on such relations which creates costs, and each group tries to control the activities of other groups. The agency model with regards to corporate governance holds that firms are units of conflict as opposed to the unitary unit notion. The conflict, in this case, is not aberrant but based on the structure of contemporary corporations.
In conclusion, it is evident that agency theory, agency problems, and corporate governance reveal the many conflicts that arise among various stakeholders such as the managers and the shareholders. Understanding the conflicting interests paves the way for developing effective solutions that may help in curbing such conflicts in a company. However, agency theory has its flaws and limitations in relations to corporate governance. However, agency theory is significant in explaining the many conflicts that exist in companies’ leadership due to varying interests among the stakeholders. It is crucial to understand that a company may be liquidated if the executive misguides the company. A good illustration is the energy company Enron where the executives hiked the prices of shares based on the weak perception that the company shares were strong in the share market (Hanks, n.d.). In such a company, the decisions of the shareholders were detrimental leading to the downfall of the company. The agency theory reveals that the decisions of the executives affect the well-being of a company. If drastic measures are taken that are irrational, then such irrational decisions may affect the company leading to huge losses and in extreme cases may lead to the closure of the company.
References
Abdulla, H. & Valentine, B., 2009. Fundamental and Ethics Theories of Corporate Governance. Middle Eastern Finance and Economics, Issue 4, pp. 89-96.
Bonazzi, L., 2007. Agency theory and corporate governance: A study of the effectiveness of board in their monitoring of the CEO. Journal of Modelling in Management, 2(1), pp. 7-23.
Davies, M., 2008. The impracticality of an international “one size fits all” corporate governance code of best practice. Managerial Auditing Journal, 23(6), pp. 532-544.
Glinkowska, B. & Kaczmarek, B., 2016. Classical and modern concepts of corporate governance (Stewardship Theory and Agency Theory). Management, 19(2).
Hanks, G., n.d. Examples of Agency Problems in Financial Markets. [Online]
Available at: https://smallbusiness.chron.com/examples-agency-problems-financial-markets-70962.html
[Accessed 25 February 2018].
Kultys, J., 2016. Quarterly Journal. Controversies about Agency Theory as Theoretical, 7(4), pp. 613-634.
Lashgari, M., 2014. Corporate Governance: Theory and Practice. The Journal of American Academy of Business, Cambridge , pp. 46-51.
Namazi, M., 2013. Role of the agency theory in implementing. journal of Accounting and Taxation, 5(2), pp. 38-47.
Panda, B. & Leepsa, N. M., 2017. Agency theory: Review of Theory and Evidence on Problems and Perspectives. SAGE journals, 10(1).
Tricker, R. I., 2010. Corporate Governance and Financial Reform in China’s Transition Economy. Corporate governance : an international review, 18(5), pp. 489-490.
Zarina, N. & Yusof, M., 2016. Context Matters: A Critique of Agency Theory in Corporate. International Journal of Economics and Financial Issues, Volume 6, pp. 154-158.
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