The Agency Theory: Principal-Agent Relationship

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Corporations today are based on, ‘Agency Theory’ (a branch of organizational behavior) wherein the behavior) wherein the owners of funds (alias principals invest their money in a company that it managed by altogether different group of people called directors and managers (alias agents) This agency relationship between shareholders and directors is based on the premise of trust; shareholders lend their money to directors under trust that the latter shall deploy the money in a manner that would maximize shareholders interests.

This theory assumes agent management will not always take decisions that will value. maximize long-term ownership value. Managers often take decisions, which further their own interest but are detrimental to the interest of the organization. This theory states that agents/managers/employees can not be trusted to act in the best interests of the shareholders and should be monitored and controlled to ensure that they follow the set policies, procedures and plans of the corporation

 

Agency Theory is defined by Chartered Institute of Management Accountants as ‘Hypothesis that attempt to explain elements of organizational behaviour through an understanding of the relationship between principals (shareholders) and agents (directors and managers). A-conflict may exist between the actions undertaken by agents in furtherance of their own self-interest and those required to promote the interest principals.

 

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