Agency Theory emerged as a response to managerial theory (Jensen & Meckling, 1976). The core idea is the relationship between stockholders (owners, principals) and managers (agents). This is often described as the principal-agent relationship. This theory assumes that managers (agents) may pursue goals that are not always aligned with those of their principles (stockholders). As a result, there is a loss in efficiency. In order to avoid misalignment of principal-agent interests, governance mechanisms have evolved to limit managerial discretions. These include:
- Performance based compensation (stock options)
- The board of directors (a monitoring mechanism)
- Corporate debt
- Market for corporate control (takeover constraint)
The costs to deal with the principal-agent problem are called agency costs.
- The scope for pursuing inefficient corporate strategies is limited. Management teams that do so will be replaced by teams that have the nest interests of owners in mind
- Organizational forms (franchising, vertical integration) may be a response to agency costs.
- Jensen & Meckling (1976)
- Fama (1980)
- Demsetz (1983)
- Fama & Jensen (1986)
- Jensen (1986)
- Eisenhardt (1989)