Agency Theory, Research Paper Example

The agency theory describes the relationship between the principle and the agent, as is the case with the relationship existing between managers and stockholders. The stockholders are the principles in the relationship while managers take up the role of the agent. Accountability of managers to stockholders is an essential component of interactions between the two parties. The managers are tasked with propagating the interests of stakeholders through ensuring the company’s operations are profitable. Stockholders act as the residual claimants in any business enterprise and this effectively eliminates them from any role within the organization. Possibly, the agency relationship between managers and stockholders may be faced with problems related to conflict of interest and moral hazards.

The first scenario that presents an agency problem within the setup is when a manager’s ownership of the common stock is less than a hundred percent. The possible agency problem can be classified as a moral hazard because the manager does not feel ownership of different business processes. The manager may act to reduce the profitability of the organization and to some extent, may lead to poor performance. Poor performance has implications on the interests of stockholders who are the residual claimants to the organizations stake. On the other hand, managers may award themselves hefty pay packages at the expense of the stockholders who rely on low operational costs and higher revenue collections. High salary allocations are part of moral hazards on the part of managers and may result in an agency problem per accounting. A conflict might arise when managers make decisions contradictory to the expectations of stockholders.

The decisions made by managers might not have the interests of shareholders from their conception and these results in an agency problem. A good example would be inflation and adjustments to books of accounting to give false impressions on the performance of the organization for selfish reasons by the manager. While ensuring job security, a manager may exaggerate the financial performance of the company in avoiding a takeover. This might be contrary to the best interest of stockholders as a takeover may be favorable. The above example represents the issue of self-interest. Self-interest might also occur in the case where a manager runs similar business activities for personal gain.

In such a case, the manager might work to accrue benefits to their company as opposed to working for the good of the firm that has employed him. Motivation of managers with the view of ensuring they act on the best interest of shareholder is dynamic and it includes considerable compensation. Compensation of managers takes the form of salaries, bonuses, and issuance of company shares. Issuance of shares can be done upon achievement of established performance levels or through executive stock options. The stock options offer reduced prices for the company’s stock to the manager and motivate them to work for the success of the organization as they feel part ownership. The other motivation factor exercised is through a direct intervention by the company’s stockholders.

Thirdly, action can be taken through a threat of firing incompetent managers and this may motivate them to work harder towards securing their employment. The final motivation element that can be used to yield better performance and results from managers is through a takeover threat. A takeover is alarming to the management team, which fears the loss of working and this might motivate them to place concerted efforts for the success of the organization.