Agency theory explains corporate governance through the relationship between principals (shareholders) and agents (managers). It is based on the separation of ownership and control in companies. The key aspects of agency theory are the agency problem that arises due to differing objectives between principals and agents, agency costs incurred by principals to monitor agents, and mechanisms like incentive compensation that aim to align goals and reduce agency costs.

1. CORPORAT GOVERNANCE
AGENCY THEORY
AYUSHI GUPTA
M.COM 1SEM
BAM 701

2. OUTLINE
INTRODUCTION
AGENCY THEORY
IMPORTANT TERMS
-AGENTS
-PRINCIPALS
-AGENCY PROBLEM
-AGENCY LOSS
-AGENCY COST
MECHANISM OF THEORY
PROBLEMS OF THE THEORY

3. INTRODUCTION
CORPORATE GOVERNANCE IS A SYSTEM BY WHICH THE
ORGANIZATION IS DIRECTED AND CONTROLLED. THIS STRUCTURE
SPECIFIES THE DISTRIBUTION OF RIGHTS AND RESPONSIBILITIES
AMONG DIFFERENT PARTICIPANTS IN THE CORPORATION, SUCH AS, THE
BOARD, MANAGERS, SHAREHOLDERS AND OTHER STAKEHOLDERS, AND
SPELLS OUT THE RULES AND PROCEDURES FOR MAKING DECISIONS ON
CORPORATE AFFAIRS.
THERE ARE FOUR BROAD THEORIES TO EXPLAIN AND ELUCIDATE
CORPORATE GOVERNANCE-
 AGENCY THEORY
 STEWARDSHIP THEORY
 STAKEHOLDER THEORY
 SOCIOLOGICAL THEORY

4. AGENCY THEORY
 THIS THEORY IS GIVEN BY ADAM SMITH WHO
IDENTIFIED AGENCY PROBLEM (MANAGEMENT
NEGLIGENCE AND PROFUSION) IN THE JOINT
STOCK COMPANY.
 THIS THEORY IS BASED ON THE CONCEPT OF
SEPERATION OF OWNERSHIP AND CONTROL.
 AGENCY THEORY IS A BRANCH OF GAME
THEORY.
 THIS THEORY IDENTIFIES THE AGENCY PROBLEM
 IT SPECIFIES MECHANISMS WHICH REDUCE
AGENCY LOSS OCCURRED DUE TO AGENCY
PROBLEM

5. AGENCY THEORY

6. IMPORTANT TERMS
AGENTS- THESE ARE THE MANAGERS APPOINTED
BY THE SHAREHOLDERS, RUN THE COMPANY ON
BEHALF OF THE SHAREHOLDERS.
PRINCIPALS- THESE ARE THE SHAREHOLDERS,
OWNER OF COMPANY DELEGATES WORK/
RESPONSIBILITY TO THE MANAGERS.

7. CONTI……
AGENCY PROBLEM- THE OBJECTIVES OF
MANAGER (AGENT) ARE DIFFERENT FROM THE
SHAREHOLDERS(PRINCIPAL) THIS CONFLICT IN
OBJECTIVE IS AGENCY PROBLEM.
 SEPARATION OF OWNERSHIP AND CONTROL
LEADS TO A POTENTIAL CONFLICT OF INTEREST
BETWEEN DIRECTORS AND SHAREHOLDERS.
 THE AGENTS’ OBJECTIVES (such as a desire for high
salary, large bonus and status for a director) WILL
DIFFER FROM THE PRINCIPAL’S OBJECTIVES (wealth
maximization for shareholders).

8. AN Agency relationship exists
WHEN:
Shareholders
(Principals)
Firm Owners Hire
Managers
(Agents)
Decision
Makers
which creates
Agency Relationship
Risk Bearing Specialist
(Principal)
Managerial Decision-
Making Specialist
(Agent)

9. CONTI….
AGENCY LOSS- IT IS THE DIFFERENCE BETWEEN THE BEST
POSSIBLE OUTCOME FOR THE PRINCIPAL AND THE
CONSEQUENCES OF THE ACTS OF THE AGENT.
AGENCY COST- THESE ARE THE COSTS BORN BY SHARE
HOLDERS TO PREVENT AGENCY PROBLEM WHICH
FUTURE RESULT AGENCY LOSS, TO MAXIMIZE OWNERS
WEALTH. THEY HAVE TO INCUR 4 TYPES OF COSTS-
-MONITORING
-BONDING
-OPPORTUNITY
-STRUCTURING

10. PROBLEMS OF AGENCY THEORY
 CONTROL OF MANAGEMENT IS NEITHER FEASIBLE
NOR REQUIRED.
 MANAGERS ACT TO OPTIMIZE THEIR PERSONAL
PAYOFFS.
 EXECUTIVES ACT TO PROTECT THEIR STATUS.
 INFORMATION ASYMMETRY.

11. MECHANISMS
THAT HELP TO REDUCE AGENCY COST AND IMPROVE CORPORATE
PERFORMANCE –
 FAIR AND ACCURATE FINANCIAL DISCLOSURE.
 EFFICIENT BOARD OF DIRECTORS.
 ACCOUNTING INFORMATION (MONITORING MANAGER
PERFORMANCE).
 CONTRACTUAL OBLIGATIONS.
 INCENTIVE SCHEMES FOR MANAGERS
(WHICH REWARD THEM FINANCIALLY FOR MAXIMIZING
SHAREHOLDER INTERESTS).