The Pros And Cons Of Agency Theory

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Shapiro (2005) on her article on agency theory postulated that in order to ensure the interests of the agent and the principal are safeguarded, a comprehensive contract is written to address the interest of both the agent and the principal. She further explained that the relationship is further strengthened by the principal employing an expert to monitor the agent (Ndhiwa & Kwasira, 2008). Agency theory is concerned with solving two problems that normally arise in agency relationship; First the problem of risk sharing, which is experienced when the agent and the principal have different risk preferences for example one may a risk taker while the other may risk averse. The other problem is Agency problem which is also referred to as principal-agent problem, according to the definition by investopedia dictionary agency problem is a problem that arise due to the conflict of interest inherent in the agency relationship. The agent is motivated by his own interest. If the agent and principal seek to maximize their own self-interests, then the agent may not always act on principal’s interests (Mannings, 2012).

In his research study Mawanda (2008) stated that internal control is one of many mechanisms used in organizations to address the agency problem. Others include financial reporting, budgeting, audit committees, and external audits. Miles (2012) observed that principals tends to have imperfect information which he needs to evaluate the agent. This leads to information

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