tejas.gaikwad.1044
Tejas Gaikwad
A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving problems that can exist in agency relationships; that is, between principals (such as shareholders) and agents of the principals (for example, company executives). The two problems that agency theory addresses are:-
1. The problems that arise when the desires or goals of the principal and agent are in conflict, and the principal is unable to verify (because it difficult and/or expensive to do so) what the agent is actually doing; and
2. The problems that arise when the principal and agent have different attitudes towards risk. Because of different risk tolerances, the principal and agent may each be inclined to take different actions.
An agency, in general terms, is the relationship between two parties, where one is a principal and the other is an agent who represents the principal in transactions with a third party. Agency relationships occur when the principals hire the agent to perform a service on the principals' behalf. Principals commonly delegate decision-making authority to the agents. Agency problems can arise because of inefficiencies and incomplete information. In finance, two important agency relationships are those between stockholders and managers, and stockholders and creditors.
The purpose of agency theory is to identify points of conflict among corporate interest groups. Banks want to reduce risk while shareholders want to reasonably maximize profits. Managers are even more risky with profit maximization, since their own careers are based on the ability to turn profits to then show the board. The fact that modern corporations are based on these relations creates costs in that each group is trying to control the others.
There are various types of agency relationship in finance exemplified as follows:-
1. Shareholders and Management.
2. Shareholders and Creditors.
3. Shareholders and the Government.
4. Shareholders and Auditors.
5. Headquarter office and the Branch/subsidiary.
An agency relationship arises where one or more parties called the principal contracts/hires another called an agent to perform on his behalf some services and then delegates decision making authority to that hired party (Agent) In the field of finance shareholders are the owners of the firm. However, they cannot manage the firm because:-
a) They may be too many to run a single firm.
b) They may not have technical skills and expertise to run the firm.
c) They are geographically dispersed and may not have time.
Shareholders therefore employ managers who will act on their behalf. The managers are therefore agents while shareholders are principal.
Shareholders contribute capital which is given to the directors which they utilize and at the end of each accounting year render an explanation at the annual general meeting of how the financial resources were utilized. This is called stewardship accounting.
- In the light of the above shareholders are the principal while the management are the agents.
- Agency problem arises due to the divergence or divorce of interest between the principal and the agent. The conflict of interest between management and shareholders is called agency problem in finance.
1. The problems that arise when the desires or goals of the principal and agent are in conflict, and the principal is unable to verify (because it difficult and/or expensive to do so) what the agent is actually doing; and
2. The problems that arise when the principal and agent have different attitudes towards risk. Because of different risk tolerances, the principal and agent may each be inclined to take different actions.
An agency, in general terms, is the relationship between two parties, where one is a principal and the other is an agent who represents the principal in transactions with a third party. Agency relationships occur when the principals hire the agent to perform a service on the principals' behalf. Principals commonly delegate decision-making authority to the agents. Agency problems can arise because of inefficiencies and incomplete information. In finance, two important agency relationships are those between stockholders and managers, and stockholders and creditors.
The purpose of agency theory is to identify points of conflict among corporate interest groups. Banks want to reduce risk while shareholders want to reasonably maximize profits. Managers are even more risky with profit maximization, since their own careers are based on the ability to turn profits to then show the board. The fact that modern corporations are based on these relations creates costs in that each group is trying to control the others.
There are various types of agency relationship in finance exemplified as follows:-
1. Shareholders and Management.
2. Shareholders and Creditors.
3. Shareholders and the Government.
4. Shareholders and Auditors.
5. Headquarter office and the Branch/subsidiary.
An agency relationship arises where one or more parties called the principal contracts/hires another called an agent to perform on his behalf some services and then delegates decision making authority to that hired party (Agent) In the field of finance shareholders are the owners of the firm. However, they cannot manage the firm because:-
a) They may be too many to run a single firm.
b) They may not have technical skills and expertise to run the firm.
c) They are geographically dispersed and may not have time.
Shareholders therefore employ managers who will act on their behalf. The managers are therefore agents while shareholders are principal.
Shareholders contribute capital which is given to the directors which they utilize and at the end of each accounting year render an explanation at the annual general meeting of how the financial resources were utilized. This is called stewardship accounting.
- In the light of the above shareholders are the principal while the management are the agents.
- Agency problem arises due to the divergence or divorce of interest between the principal and the agent. The conflict of interest between management and shareholders is called agency problem in finance.