Agency theory is a group of concepts describing the nature of the agency relationship deriving from the separation between ownership and control.
By accepting to undertake a task on their behalf, an agent becomes accountable to the principal by whom they are employed. The agent is accountable to that principal.
Directors (agents) have a fiduciary responsibility to the shareholders (principal) of their organisation (usually described through company law as ‘operating in the best interests of the shareholders’).
Agent objectives (such as a desire for high salary, large bonus and status for a director) will differ from the principal’s objectives (wealth maximisation for shareholders)
Key concepts of agency theory:
An agent is employed by a principal to carry out a task on their behalf.
Agency refers to the relationship between a principal and their agent.
Agency costs are incurred by principals in monitoring agency behaviour because of a lack of trust in the good faith of agents.
The most important agency costs are the external audit fee, attending meetings and reading both annual reports and analyst’s reports.