Agency Theory of Corporate Governance - Explained
What does it mean for Officer and Director Decision Making
Written by Jason Gordon
Updated at September 25th, 2021
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Table of Contents
What is the agency theory of business entities?Discussion QuestionAcademic ResearchWhat is the agency theory of business entities?
Agency theory posits that corporations act as agents of its shareholders. That is, shareholders invest in corporate ownership and thereby entrust their resources to the management of the directors and officers of the corporation. In larger corporations, there is often a sharp divergence between the short and long-term interest of officers and shareholders. This is primarily brought on by short-term demand for profits and the asymmetry of information that officers and directors possess compared with that of shareholders.
The divergence of interest between officer, director, and shareholder is thought to influence the actions and decisions of officers and directors who may become detached from shareholder interests.
Corporate governance rules seek to establish a legal framework similar to that of the agent-principal relationship. These rules seek to align the incentives of officers and directors with those of shareholders. They seek to establish norms and customs that prevent the adverse results of divergent corporate interests. Further, agency theory lends itself to the duties that officers or director owe to the corporation.
Next Article: Role of Shareholders of the Corporation Back to: CORPORATE GOVERNANCE
Related Topics
- What is Business Governance?
- Who are the members of a corporation?
- What is a closely-held corporation?
- What is a Private Company vs a Public Company?
- What is the role and purpose of the corporation?
- What is the Agency theory of corporate governance?
- What is the Stakeholder theory of corporate governance?
- Shareholder-Centric Perspective
- Shareholder Value
Discussion Question
How do you feel about the principal-agent view of the corporate form? What are the advantages and disadvantages of this view? Do you believe that corporate governance procedures are effective in aligning officer, director, and shareholder incentives? Why or why not?