Agency theory is a principle used to explain and solve problems in the relationship between business leaders and their representatives. Most often, this relationship is between shareholders as officers and company officers as agents. Another example of agency theory is the relationship between investor and manager. Clients delegate decision-making authority to agents. Since many decisions affecting the client financially are made by the agent, disagreements and even differences in priorities and interests can arise. The agency theory assumes that the interests of a client and an agent do not always coincide. This is sometimes referred to as the principal-agent problem. Various proponents of the agency theory have suggested ways to resolve disputes between agents and principals. This is called “reducing agency losses.” Agency loss is the amount that the client claims was lost because the agent acted against the client`s interests.

Other types of agency problems do not develop from different knowledge, but from different programs. Instead of maximizing shareholder interests, managers can implement policies that benefit their own results. The agency theory postulates that companies act as representatives of their shareholders. This means that shareholders invest in the company`s assets, thereby entrusting their resources to the management of the company`s directors and officers. In large companies, there is often a strong divergence between the short- and long-term interests of senior management and shareholders. This is mainly due to the demand for short-term profits and the asymmetry of information that managers and directors have compared to that of shareholders. When it comes to business and the concept of agency theory, there are different types of relationships that are closely related and face some kind of disagreement. Risk is another cause of agency problems, as agents and clients often assess risk differently. The Fin2Learn website states that due to the lure of greater rewards, shareholders may be willing to tolerate greater risk as managers.

Managers who don`t see the same benefits from risky moves may be more cautious. Employees are agents, while employers are clients in agency theory. Employees are hired in a company to work towards the achievement of the organization`s goals. However, the growing number of corporate frauds is impacting employer-employee relations. Employees violate the organization`s ethics, resulting in significant financial and reputational damage. Sometimes the damage caused by corrupt employees is irreversible and an organization must ultimately run the business. Agency theory states that principals and agents act in their own interest, which can work for their mutual benefit. Senior management, for example, is motivated by high salaries or company benefits. To keep these things going, they maximize returns for shareholders.

Owners are motivated to reward competent leaders to generate profits. By definition, an agent uses the resources of a principal. The client has entrusted money but has little or no daily input. The agent is the decision-maker, but takes little or no risk because the losses are borne by the principal. The agency`s theory deals with disputes that occur primarily in two key areas: a difference in objectives or a difference in risk aversion. One objection to the agency theory is that it is “based on the assumption of self-interested agents seeking to maximize personal economic prosperity” (Bruce et al., 2005). The challenge, then, is to get agents to set aside their personal interest or work in a way that maximizes their personal wealth while maximizing the client`s wealth. Therefore, a standard of duty and action of the agent is necessary, not because agents are universally selfish, but because there is a potential for differences between the interests of the client and the agent.

The Corporate Finance Institute describes two main methods of getting agents to act in the interests of constituents rather than in their own interests. One is to create an explicit contract that specifies what the agent is obligated to do. The second is to reward them financially when they deliver by offering them stock options or bonuses. These solutions have their parallels in other agency relationships. Performance-based pay is one example. Another is that a deposit is accounted for to ensure delivery of the desired result. And then there`s the last resort, which is simply firing the agent. As mentioned throughout the text, agency theory explores the distinctive relationship between a client and their agent.

Throughout the relationship, a number of actions and decisions are taken by the agent on behalf of the principal. In order to reduce the potential influx of agency issues, it is crucial that the client and agent are completely transparent with each other. For this reason, school principals often spend money monitoring their agents. A thorough review is not cheap, but it can detect many types of agency problems. Protecting their interests may also impose costs on agents, for example by requiring them to provide a guarantee against their failure. As long as the costs are less than the benefits both parties derive from the agency-client relationship, the extra security is worth it. Agency theory analyzes the problems and solutions surrounding the delegation of tasks from clients to agents. Agents designate agents to perform certain tasks. Officers are authorized to perform the assigned tasks or work. Problems arise from conflicts of interest and information asymmetry between client and agent. The theory deals with establishing agency relationships to minimize the likelihood of disputes and other problems between agents and clients.

The functioning of a country`s government is one of the most widely used examples of agency theory. The people elect political representatives to govern the nation in the manner that best serves their interests. The representatives of the various political parties promise voters that they will bring the reforms into line with the interests of the country`s citizens. However, voters feel cheated when their elected representatives do not keep their guaranteed promises. Here, the electorate acts as a client and elects civil servants as their agents. Agency theory explains how best to organize relationships in which one party determines the work while another party does the work. In this regard, the client hires an agent to perform the work or perform a task that the client is unable or unwilling to perform. For example, corporate principals are the shareholders of a corporation who are attached to the agent, i.e. the management of the company, delegates to perform tasks on their behalf. The agency theory assumes that both the client and the agent are motivated by self-interest. This self-interest assumption condemns the agency theory to inevitable inherent conflicts.

Thus, if both parties are motivated by self-interest, agents are likely to pursue selfish goals that deviate from the principal`s goals and even conflict with them. Nevertheless, agents must act in the sole interest of their principals. Agency theory is a theory of management and economics that attempts to explain relationships and self-interest in business organizations. It describes the relationship between principals/agents and delegation of control.