Agency Theory and Shareholder Value
Agency theory is the study of problems characterized by disconnects between two cooperating parties: a principal and an agent. Agency problems arise in situations where there is a division of labor, a physical or temporal disconnect separating the two parties, or when the principal hires an agent for specialized expertise. In these circumstances, the principal takes on the agent to delegate responsibility to him. Theorists have described the problem as one of “separation and control”: agents cannot be monitored perfectly by the principal, so they may shirk their responsibilities or act out of sync with the principal’s goals. The information gap and the misalignment of goals between the two parties results in agency costs, which are the sum of the costs to the principal of monitoring, the costs to the agent of bonding with the principal, and the residual loss due to the disconnect between the principal’s interests and agent’s decisions.
Lastly, the shareholder value theory seeks to reform the governance of publically-owned firms in order to decrease the principal-agent information gap. The model calls for firms’ boards to be independent from their corporate executives, specifically, for the head of the board to be someone other than the CEO and for the board to be independently chosen. An independent board can best objectively monitor CEO undertakings and risk. Shareholder value also argues in favor of increased financial transparency. By making firms’ finances available to scrutiny, shareholders become more aware of the agent’s behavior and can make informed choices about with whom to invest.
Read more about this topic: Shareholder Value
Famous quotes containing the words agency and/or theory:
“It is possible that the telephone has been responsible for more business inefficiency than any other agency except laudanum.... In the old days when you wanted to get in touch with a man you wrote a note, sprinkled it with sand, and gave it to a man on horseback. It probably was delivered within half an hour, depending on how big a lunch the horse had had. But in these busy days of rush-rush-rush, it is sometimes a week before you can catch your man on the telephone.”
—Robert Benchley (1889–1945)
“We commonly say that the rich man can speak the truth, can afford honesty, can afford independence of opinion and action;—and that is the theory of nobility. But it is the rich man in a true sense, that is to say, not the man of large income and large expenditure, but solely the man whose outlay is less than his income and is steadily kept so.”
—Ralph Waldo Emerson (1803–1882)