Meaning of Agency Theory - Essay Sample

Agency theory refers to the branch of financial economics that deals with conflicts of interest existing between individuals having interest in assets that are the same. The theory illustrates the relationships occurring between principals like shareholders and agents like managers of the company (Pepper & Gore, 2015). As per the agency theory, the principal is the one who delegates/hires an agent to carry out duties. Agency theory helps in aligning the goals set by the principal to prevent agency problem that might occur between company managers and shareholders or between bondholders and shareholders. The other role of agency theory is allowing the agent and principal to reconcile with each other in case of conflicts.

2. Key Models and Findings Related to Agency Theory

Some of the key models that relate to agency theory include management, political science as well as law.

2.1 Agency Theory and Management Model

The management model is related to agency theory and it originated in early 1970's. The model calls for the adoption of policies in the agent-principal relationships to ensure that the relationship between the two does not have conflicts (Argote & Greve, 2013). The main focus of agency theory-management model was to align incentives through compensation policies. The finding of the agency theory and management model is that it led to the considerable correlation of trade-offs existing between outcome orientation and behavior-orientation. The behavioral orientation of this model focused on salary while its outcome orientation focused on bonuses, commissions, piece rates as well as equity ownership (Hannafey & Vitulano, 2013). The other finding of the agency theory and management model was the establishment of appropriate monitoring strategies in a business like agent-to-principal control system.

2.2 Agency Theory and Political Science Model

Political science model relates to agency theory originate in early 1973 taking an economics paradigm rather than the sociological one. The model asserts that principals in politics delegate to agents authorities in carrying out their political preferences (Eisenhardt, 2013).The relationship between political principals and their agents have chances for the occurrence of conflicts. The presence of information asymmetries between political principals and their agents, the former are not sure if agents are accomplishing their will. Also, political principals face the challenge of moral hazard, adverse selection as well as agent opportunism (Birken et al., 2017). The findings of the political science model that relates to agency theory were the contriving of incentives by political principals in aligning the interests of agents with their own by monitoring agent's activities and behaviors.

2.3 Agency Theory and Law Model

The other model relating to agency theory is the law model in the perception of the economics but not of legal view. In accordance with the law model, the conceptual relationship between the principal manifests the assent of an agent through the acts of the latter but on behalf of the former (Bryant & Davis, 2012). In the legal principal case, there are chances for conflicts because of the choice of acting through an individual in lieu of one's self. From the models there are findings, firstly, it led to a way out of holding principals' responsible for any actions done by agents. The other finding of the model was the establishment of a demarcation of agency relationships and their sources of authority as well as the realization of agents obligations owed to their principals.

3. Key Implications of Agency Theory for Management Practices

There are key implications through the application of agency theory for the practice management. The first implication is arriving at the compensation of company managers with minimal conflicts (Bahli & Rivard, 2013). Companies are in a position to compensate managers based on the changes in stock prices. Through compensation of managers following the changes in the stock price, the costs of agency become low because the management has great incentives for maximizing the wealth of shareholder. As a result, the management ends up being in a position to control the earnings of the organization within the fluctuating economic events (Pepper & Gore, 2015). The management as well in the position of hiring and retaining talented managers under contractual terms as a way of protecting the interests of shareholders in spite of the fluctuating economic events.

The other implication of agency theory for the practice of management is the establishment of an efficient and effective monitoring and controlling mechanism by the management. By following the precepts of agency theory, shareholders find a way of monitoring the actions of agents using the most cost-effective and efficient mechanisms (Hannafey & Vitulano, 2013). The management practice is efficient because of the presence of monitoring of managers. Monitoring leads to reduced abuse of position by company managers as well as irresponsible expenditure of Company money. The management is in the position of monitoring and controlling the actions and behaviors of the agent on behalf of shareholders. There are reduced chances of managers' engagement in risk investments (Pepper & Gore, 2015). Therefore, the management works out on how to protect the wealth of the shareholders, a situation that ensures that the compensation is by performance.

Lastly, the agency theory application within the company implies allowing a better relationship between the management and the shareholders. In return, a good relationship between the management and the shareholders leads to the establishment of a stable corporate environment to better satisfaction of shareholders (Bahli & Rivard, 2013). The good relationship between the management and the shareholder ensures that managers act and behaves by the contract demands. The outcome is an enhanced performance that increases the profit of the organization. The other implication about a better relationship between the agent and the principal is the reduction of cost of capital, a situation that yields to economic development in a sustainable manner (Eisenhardt, 2013). Consequently, the management operates in a stable corporate environment because the application of agency theory reduces conflicts between the two parties.

4. The Importance of Studying Agency Theory

Studying agency theory is important to students from both the moral and career point of view. Beginning with the career point of view, we explore agency theory for application in future at the place of work. From the demands of agency, theory that focuses on reducing conflicts between the principals and agents of Companies (Bahli & Rivard, 2013).The knowledge acquired by studying agency theory will help students on how to become reliable manager of Companies. Students aspiring to become managers and shareholders of Companies will know how to align goals set by the principles to prevent agency conflicts. Moreover, knowledge acquired from studying agency theory is of importance to students, as it will help on how to protect the wealth of shareholders by controlling and monitoring agents. From agency theory study, students are acquiring skills on how to ensure the performance of agents by controlling and monitoring the acts and behaviors of company agents (Hannafey & Vitulano, 2013). Consequently, studying agency is not in vain as it yields to future company shareholders and managers who will work with each other without conflicting interests.

The other reason why studying agency theory is of importance relates to the moral development of students. Knowledge acquired from agency theory helps in the moral development of responsibility and decision-making (Bryant & Davis, 2012). Since the suggestion of agency theory is that people are either agented or autonomous, it helps in developing the moral section of students. From the autonomous suggestion of agency theory, students learning the theory become responsible in the society for their actions and behaviors. Studying the agency theory develops the moral value of responsibility in learners as the feeling of guilt for the mistakes made from actions and behaviors starts to build up. On the other hand, morality development after studying agency theory occurs from the agented point of view as learners perceive themselves as agents of other people's will. The realization of operating as agents of other people leads to the development of the moral value of respecting authority (Eisenhardt, 2013). Consequently, studying agency theory yields to respect of authority in life in accomplishing the duties assigned accordingly.

5. Use of Agency Theory in Management

There are various ways in which agency theory can end up applied in my area of research. The first ways in which agency theory is applicable is the process of monitoring the actions and behaviors of agents (Pepper & Gore, 2015). The shareholders will use the performance of the agent in compensation to that his will ends up accomplishing. In reducing losses, the shareholders will use a contractual mechanism to ensure that compensation is per the services offered by the manager. Additionally, the relationship between the principal and the agent will employ agency theory to ensure that the wealth of shareholders ends up protected during low share costs (Eisenhardt, 2013). The compensation of the manager will correspond with the fluctuating economic events, a situation that will protect the company from collapsing.

The second application of agency theory is the establishment of a better relationship between the Company executives and the shareholders. The theory will help the shareholders who are the principal in the relationship to delegate or hire Company executive to perform duties on their behalf (Hannafey & Vitulano, 2013). By the application of the agency theory, the conflicts between the Company executives and the shareholders will end up reduced leading a stable business environment. As a result, the employer will work out to ensure that there is a high performance by adding value to the services offered to the Company. On the other hand, the shareholder will offer incentives to motivate the managers (Bryant & Davis, 2012). In the end, each side of the relationship will end up benefitting from the efforts rendered, a situation that reduces conflicts between the Company executives and shareholders.

The third application of agency theory in my area of business is an efficient allocation of resources. The company will work under the monitoring and the control of shareholders, a condition that will allow for efficient allocation of resources. Managers will concentrate on projects that develop the company because of auditing yielding to Company development (Bahli & Rivard, 2013).The efficient allocation of resources by the managers will include the consideration of the positive amounts of perk consumption. Consequently, the performance of the organization will improve because of the efficient allocation of the resource by the manager on behalf of shareholders.

References

Argote, L., & Greve, H. R. (2013). A behavioral theory of the firm40 years and counting: Introduction and impact. Organization Science, 18(3), 337-349.

Bahli, B., & Rivard, S. (2013). The information technology outsourcing risk: a transaction cost and agency theorybased perspective. Journal of Information Technology, 18(3), 211-221.Birken, S. A., Bunger, A. C., Powell, B. J., Turner, K., Clary, A. S., Klaman, S. L., ... & Chatham, J. R. S. (2017). Organizational theory for dissemination and implementation research. Implementation Science, 12(1), 62....