Objective of agency theory

Objective of agency theory
Sugeet -

The objective of the agency theory is to reconcile the differences that exist between the principal and the agent.

Here's an example: in a publicly traded company on any given worldwide stock exchange, you have the principal party (the shareholder) and you have the agent (the board of directors and the company's management). The Agency problem that exists is when the shareholder disagrees with the agent as to what the company is doing to maximize the shareholder's wealth. This differing opinion creates a conflict of interest and the Agency theory is an academic way of trying to explain how these conflicts get resolved.

Hope this makes sense.

> An objective specifieswhat a decision maker is trying to accomplish and by doing so provides measures that can be used to choose between alternatives.
> If an objective is not chosen there is no systematic way to make decesions that every business will be confroonted at some point of time.
> A theory developed around multiple objectives of equal weight will create quandaries when it comes to making decesions.
> The cost of choosing a wrong decesion can be significant.

Agent is the Management (Board of Directors) appointed for the best interest of the stakeholders (shareholders, banks, community, etc.).

Previously my friend answered very well. So, I will just add on a little extra as an example.

1. Shareholders Invest Money to Maximize their Wealth (Dividend or Capital Gain)

2. Agents may be risk averse (Unwilling to take risks) and therefore do not invest in profitable projects because they are risky. So, the shareholders are derived from the dividends (that they are supposed to get periodically) or the increased Share price (capital gain/selling the shares in the market).

3. Another scenario could be that the shareholders hold shares of many companies and they want stable yet risk adverse income whereas Management/Board of Directors (Agent) want to increase their incentives by investing in risky projects that may deteriorate the company position.

4. Therefore, Agency Conflict has been a big issue over the years. The conflicting choices of money suppliers (Shareholders for say) and the utilizers of the funds (The Management).

5. Agency Cost is another factor where directors are paid for their service. If they do not add value to the organization, it would not be in the best interest of the shareholders. Agency cost is incurred thereof.


Objective would be to keep the shareholders' expectation as the utmost priority whilst protecting the investments of the company in the long run. During AGM, Shareholders vote, choose the auditor for the forthcoming year, join open floor question and answers about the prospects of the company. The objective is to formulate strategies so that the funds provided by the shareholders and others are managed efficiently and effectively by the Agents/Board of Directors/The Management.


Hope this helps a little.

Arunav