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Agency Theory

Agency theory in the early 1970s has been very successful and active area for research in
economics, finance, management and related disciplines. After introduction in modern form by
Jensen and Meckling (1976), agency theory has been the subject of extensive research. Existing
research has applied their model extensively across numerous fields, ranging from economics
through to international relations. Generally, appearance of agency theory is no doubt that it has
been widely adopted. Surprisingly, however, the model correctly predicted in the simplest case
only the specific investigation of the phenomenon. In some cases, a simple agency models have
limited success in other context as well.
In modern enterprise, agency theory argues that in which owns the shares are widely held
and management practices to maximize shareholder returns from those asked to leave (Berle &
Means, 1932; Pratt & Zeckhauser, 1985). In agency theory terms, the owners are principals and
the managers are agents and there is an agency loss which is the extent to which returns to the
residual claimants, the owners, and fall below what they would be if the principals, the owners,
exercised direct control of the corporation (Jensen & Meckling, 1976). Agency theory specifies
which institutions to reduce losses mechanism (Eisenhardt, 1989). These measures include
economic incentives for executives they create incentives for the best interests of shareholders.
These plans typically include plans, shares acquired pursuant to executives, perhaps at a lower
price, thereby adjusting the economic interests of managers with shareholders (Jensen &
Meckling, 1976).
Fama (1980) suggests that the primary monitoring of managers comes not from the
owner but from the managerial labor market. If the managerial labor market is competitive both
within and outside the firm, it will tend to discipline the manager. Market for corporate control
alternative management teams competes for the right to manage corporate resources (Jensen &
Ruback, 1983). Rolls hypothesis (1986) suggests that the agency problem in which managers
infected by hubris try to maximize value, but over-estimate that value that they buy, is not
checked by the control mechanism stated above. Jensen (1988) argues that the market for
corporate control is creating large benefits for shareholders and for the economy as a whole by
loosening control over vast amount of resources and enabling them to move to their highest-
In term of strength, agency theory is concerned with resolving two problems that can
occur in agency relationships. The first is the agency problem that arises when the desires or
goals of the principal and agent conflict (Yukis, 2010). The second is the agency problem that
arises when it is difficult or expensive for the principle to verify what the agent is actually doing
(Amagoh, 2009).
The first problem of agency theory is that the client cannot confirm that the agent has
behaved appropriately (Eisenhardt, 1989). Second, the risk-sharing appears, principal and agent
have different attitudes to risk issues (Drever et al, 2007). According to the shareholders, it is
generally accepts the risk that have higher potential of return. This view is quite different from
managers as they are willing to take less risk of the company because that is normally their key
source of income. The third problem is known as dividend retention which is the ability of
managers to pay out less of the companys earnings in dividends and retain more so that they
could invest in the companys growth which will benefit them the ability to return (Cheng,
Cullinan & Zhang, 2014). The fourth problem is the horizon disparity and can easily be linked to
long-term incentive bonus, in order to overcome this problem (Arnold & Lange, 2004). This is a
particular problem if the manager wants to stay in the company for a short time, and the results
of the company involved, but they manage.
Agency theory is important, but it is a controversial theory. Every researchers have their
own and different finding when there review of this theory. The main idea of agency theory
concerned with resolving the problems in the agency relationship between principals and agents
of the principals. Agency problems can arise because of inefficiencies and incomplete
information. In the financial sector, the relationship between two important institutions are those
shareholders and managers, as well as between the shareholders and creditors.