Agency Theory

Numair Ahmed Sulehri

Shoaib Hassan

Attiq Ullah Baber

Introduction History Definition Alternate name(s) Main dependent Main independent Diagram/schematic of theory Links from this theory to other theories Conclusion

Theory NameAcronym

construct(s)/factor(s)

construct(s)/factor(s)

Concise description of theory

Originating author(s)Seminal articlesOriginating area

Links to WWW sites describing theory

IS articles that use the theory

Originating author(s)

Alchian and Demsetz (1972)

Jensen and Mekling (1976)

Eisenhardt (1985, 1989)

Defining Agency Theory

“One party (termed the “principal”) seeks to achieve some outcome but requires the assistance of another (termed the “agent”) to carry out a necessary activity”

(Scott, 1998)

Best Productivity

“The central dilemma investigated by agency theorists is how to get the agent to act in the best interests of the principal when the agent has an information advantage over the principal and divergent goals or interests” (Chong)

Key Terms in Agency Theory

Principal: An individual, or group of individuals, who delegates authority to another to achieve a certain outcome, and whose welfare is affected by the choices of the agent. (Eisenhardt, 1989)

Agent: The individual, or group of individuals, who set out to execute an activity or set of activities to fulfill the principal’s goals or objectives. (Eisenhardt, 1989)

Asymmetric Information: A difference in information between two parties. Many economists rely on economic models that assume both parties in a transaction have perfect information. But information in the real market is often asymmetric (Chong).

Managerial Application

Manager (Principal) Vs Labor (Agent)

Employers (principal) vs Employees (agents)

Shareholders (principal) vs Managers (agents)E.g. Enron

Alternate name: Principal-Agent Problem Main dependent constructs

1. Efficiency,

2. Alignment of interests,

3. risk sharing,

4. successful contracting Main independent construct(s)/factor(s)

Information asymmetry, contract, moral hazard, trust

Main independent construct1. Information asymmetry

2. Contract,

3. Moral hazard, ( Ethics)

4. Trust

Basic idea of Agency Theory (P: Principal, A: Agent)

Information Asymmetry

Occurs “when the principal does not know exactly what the agent has done”

(Eisenhardt, 1989)

Agency problem:Goals of principal and agent are differentPrincipal cannot assess the agent’s

behaviour, i.e. the outcome

Unit of analysis Contract between principal and agent Human assumptions Self interest Bounded rationality Risk aversion  Organizational assumptions Partial goal conflict among participants Efficiency as the effectiveness criterion Information Assumption Information as a purchasable commodity Contracting problem Agency (moral hazard and adverse selection) Risk sharing Problem domain Relationships in which the principal and agent have partly differing goals

and risk preferences (e.g. compensation, regulation, leadership, impression management, whistle blowing, vertical integration, transfer pricing)

Conclusion

Programmability: “the degree to which appropriate behavior by the agent can be specified

in advance” (Eisenhardt, 1989) Programmed behavior is easier to observe

Information systems: Budgeting systems, reporting procedures, supervisory boards

Measurability of outcomes: Positively related to programmability

Long term relationships: Information asymmetry decreases over time in a principal/agent

relationship

References

Chong, Jan. Visited October 2006. “Agency Theory - Review”. http://www.stanford.edu/~jchong/articles/quals/Agency Theory - Review.doc

Eisenhardt, K. M. 1989. Agency Theory: An Assessment and Review. The Academy of Management Review, 14(1): 57-74.