Agency theory

The terms agency theory or principal-agent relationship subsume microeconomic models that essentially describe a delegation. One person or party, the principal, entrusts the other person or party, the agent, with a task. The principal can only partially control the agent. We are looking for a remuneration structure or a form of profit sharing so that the agent, in his own interest, behaves in a way that meets the goals and wishes of the principal as much as possible.

To study the delegation, microeconomic models were built. It used to be assumed that the client had complete information about all actions of the contractor or could easily obtain it, for example through appropriate controls or through detailed reports. Then the level and type of effort and commitment of the agent could be directly contracted.
Agent and principal can freely agree performance and consideration. In reality, the assumption of complete information is seldom given. For about twenty-five years, therefore, microeconomic models have been created in which one party (client, principal) can neither observe all actions, nor the efforts or qualifications of the other party (contractor, agent) free of charge.

The agent has room for maneuver that the principal cannot oversee. Because the behavior and use of the agent cannot be determined beyond doubt, even in retrospect, it is impossible to make it part of the contract. The specialty of the agency theory is the asymmetrical information. Even in retrospect, the principal cannot determine exactly how much the agent really put in or tried to fulfill the task.

· The agent has discretionary room for maneuver, and the principal himself cannot check all the agent's actions in detail ex post. On the one hand it will be impossible to measure the intention and the real commitment, on the other hand the examinations cause costs.

· The agent, however, has his own goals, for example he appreciates comfort and feels the individual costs of increased exertion. The agent will therefore behave within the scope of his discretionary scope of action in a way that does not necessarily have to harmonize with the goals of the principal.

· The principal would like to design the remuneration structure in such a way that the agent, now in his own interest, advocates something that meets the goals of the principal.

Applications of agency theory include the relationship between the shareholders (as principal) and the chief executive officer as agent) of a public company.
Agency theory does not assume that managers secretly want to reduce their workload in order to have more free time. Everyone will agree that top managers are there for the company day and night, neglecting their health and family. But top managers can present essential decisions such as large investments and acquisitions to the shareholders in such a way that it remains open to what extent striving for value creation and to what extent egocentricity and the desire for the Empire Building may lead.

In the case of acquisitions in particular, the behavior of manager agents can be to the detriment of shareholder principals. Often the distortion - away from the "pure" value orientation towards personal "preference" - is not even fully conscious of the top managers. In order for a top manager to be able to lead and convince powerfully, he or she must be self-confident. For this reason, there are supervisory bodies that tend to exercise the role of critical and distanced control. Empire Building is not just an expression of self-confident bosses, but a sign of insufficient control by the board and false incentives.

Of course, there are also reverse agency relationships, for example in the sense that managers feel they are “dependent” on all or individual equity providers and ask themselves what they can do to get shareholders to be more loyal to the company. In this case, the managers would be the principals and the shareholders would be the agents.

In a real life cooperation, the cooperation between two parties relates to several dimensions, and the asymmetric information can exist in one direction in some of these dimensions and in the opposite direction in others. The approaches described are of great practical importance for value creation management. The recommendation is to provide suitable motivation and to try in the organization to avoid losses due to asymmetrical information distribution.

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