Agency Theory
Background to the Study
The increasing number of business failures and some widely publicized frauds has encouraged firms to put more emphasis on their internal control systems, which are specific to their particular operating environment. Management is under increased pressure to enhance the effectiveness of internal control and to effectively communicate this to the board of directors and shareholders (Kuhn and Sutton, 2010). Reference groups like auditors, suppliers and customers are also interested in internal controls since they may affect long term confidence in reporting, accountability and in the corporate form of organization (Rittenberg and Schwieger, 2001).
Response to financial scandals such as Enron or WorldCom has resulted
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Agency theory posits that agents have more information than principals and that this information asymmetry adversely affects the principals’ ability to monitor whether or not their interests are being properly served by agents. Furthermore, an assumption of agency theory is that principals and agents act rationally and use contracting to maximize their wealth. A consequence of this assumption may be the ‘moral hazard’ problem (Jensen & Meckling, 1976), indicating that in an effort to maximize their own wealth, agents may face the dilemma of acting against the interests of their principals. This Theory will guide this study because studies have shown that effective internal control reduces agency costs (Abdel-khalik 1993; Barefield et al., 1993) and again, due to the fact that Internal control is one of the many mechanisms used in business to address the agency problem (Jensen and Payne …show more content…
Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interest of the company and shareholders and should facilitate effective monitoring, thereby encouraging firms to use resources more efficiently. The BOD is thus responsible for providing guidance and oversight for senior management and ensuring that an appropriate Internal Control System is in place and effective, meaning it ensures that the expected objectives are attained (Solomon,
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