Agency Theory Case Study

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Agency theory was developed by Jensen and Meckling in 1976 who defined agency relationship as a contract under which one or more persons delegate decision making authority to another person to perform some services on their behalf. Agency theory explores the relationship between a principal and an agent. In the context of a company, the manager (agent) acts on behalf of the shareholder (Principal). Company owners empower managers to make decisions on their behalf. Shareholders do not actively participate in the management of their investments instead they engage managers to act on their behalf. This makes managers have information advantage hence creating incentive to maximize their own value as opposed to that of the shareholders. Scott (2012)…show more content…
Secondly problem of risk sharing arising from diverse attitude of the principal and the agent towards risk, the problem is each tends to select a different action when the risk happens (Depoers, 2000). One way in which agency problem can be minimized is by means of contract, it helps in bringing shareholders interest in line with managers’ interests (Healy and Palepu, 2001).These contracts require management to disclose relevant information to investors and to creditors. Consequently principal can check if the management complied with the contract agreements and evaluate if their decisions are in alliance with their interest, monitoring managers by mean of contract comes with a cost at the expense of manager’s compensation and in order to reduce any potential conflict, principals incur monitoring costs while agents incur bonding costs which guarantees the interest of the principal is prioritized. Agency costs are the total of monitoring costs, bonding costs and residual…show more content…
The capital need theory can help to explain the reasons behind the disclosure of voluntary information made by companies. Healy and Palepu (2001) pointed out that managers are motivated to disclosure more by decreasing information asymmetry problem and eventually decreasing cost of external financing. The capital need theory predicts that with increased voluntary disclosure investors’ uncertainty is minimized which results in lowering company’s cost of capital (Schuster and O’Connell, 2006). The theory suggests that voluntary disclosure helps in achieving a company’s need to raise capital at a low cost (Choi, 1973). This theory implies that company’s managers are motivated to disclose more information to enables them to raise capital on the best available terms (Gray et al.,
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