Agency Theory Essay

Michael (2015) defined agency theory as the branch of financial economics that looks at conflicts of interest between people with different interests in the same assets. Agency theory raises a fundamental problem in organizations called self-interested behavior. This is when managers seek to maximize their own personal gains at the expense of shareholders.
Managers, acting as the agents for shareholders are supposed to make decisions that will maximize shareholders wealth. But when managers seek their own interest other than the interest of shareholders, agency conflict emerges.The separation of ownership and control can lead to managers of companies taking actions that may not tend to maximize shareholder wealth, due to the adequate knowledge

This results in agency costs. Jensen and Meckling (1976) defined agency costs as the sum of monitoring expenditure by the principal to limit the aberrant activities of the agent.
Awareness of the results flowing from the incidence of agency problems have led to the placement of much attention on monitoring mechanisms designed to reduce the degree of agency conflict.
As part of the monitoring mechanisms, is the formation of board of directors considered to be one of the surest ways of minimizing agency conflict. Michael (2015) defined board of directors as a body of elected or appointed members who jointly oversee the activities of a company or organization.
Major responsibilities of board of directors include establishing vision, mission and values to be promoted throughout the company, setting structures and strategies that underpin the corporate strategy, monitoring and evaluating the implementation of policies, and exercising accountability to

In the combined leadership structure the CEO of the firm also works as the chairman of the board. In the split structure on the other hand the powers and the responsibilities of CEO and that of chairman of the board are separated (Ponnu, 2008). The Boards of Directors are expected to be more independent and efficient in fulfilling their monitoring duties when the CEO is not the chairman of the board (Osma, 2006). The agency theory argues that CEO dominance can lead to opportunistic behaviour which can decrease shareholder wealth. Al-Harkan (2005) reports that the importance of separating the responsibilities of the chairman and the CEO will help companies achieve an effective corporate governance system.
A number of barriers affect the effectiveness of the Board of Directors, some of which are the lack of rotation plans, committee structure not functioning properly, lack of strategic plans, and the failure to take unproductive members off the