Agency theory and beyond

Question 1

What are the two main shortcomings of the agency theory?

Answer 1

1. Agents are assumed to be rational
2. Agents are assumed to be purely money motivated; power and control is overlooked

Question 2

What biases are agents driven by? (8)

Answer 2

• Confirmation bias
• Anchoring bias
• Illusionary bias (search for patterns)
• Small sample bias
• Hindsight bias
• Personality and stress
• Herding bias
• Success and failure attirbution bias

Question 3

How can incomplete contract affect the level of investment?

Answer 3

Under complete contract: investor maximises the function R = R(m) - c(m) - S
where R = net revenue, R(m) = gross profit, c(m) = cost of goods and S = renumeration

Under incomplete contract: manager has bargaining power over their S
where if they request S = 0.5R, the optimal level of investment for the investor is halfed

Question 4

What are the 3 types of agency problems?

Answer 4

Type 1. Principal vs agent
Type 2. Majority vs minority shareholders
Type 3. Shareholders vs other stakeholders

Question 5

What 3 types of costs are associated with type 1 agency problem?

Answer 5

1. Monitoring costs
2. Bonding costs
3. Residual costs

Jensen and Meckling (1976)

Question 6

On what 4 grounds might the agents disagree with the principal?

Answer 6

1. Moral
2. Risk aversion
3. Time horizon
4. Earnings (both renumeration and company’s retained earnings)

Question 7

What are monitoring costs? Give examples

Answer 7

Monitoring costs: costs of controlling the agent

E.g., audit fees, legal advice on contract construction, cost of hiring

Question 8

What are bonding costs? Benefit and disadvantage

Answer 8

Costs bared by the agent, initiatives they take on to reassure the shareholders prior to official monitoring

Benefit: gives the agent trust to decide what information to disclose
Disadvantage: as bonding exercises come at an expense to utility = less initiative

Question 9

What are residual losses?

Answer 9

Inefficiencies due to disagreements between agent and the principal that have not been eliminated by the monitoring and bonding costs

Question 10

What is stakeholder governance theory?

Answer 10

A theory that agents should consider various group of stakeholders rather than purely shareholders

Supports the idea that firms should maintain relationships with stakeholders through contracts and involve them in the decision making

Question 11

What is network governance theory?

Answer 11

The idea that a firm should prioritise informal networks which avoid bureaucracy

Note: network membership refers to the relationships rather than industries, sizes or geographical proximity of firms

Prominent in everchanging industries where completion of complex tasks requires expertise, optimal to outsource

Question 12

What is stewardship governance theory?

Answer 12

• People must be given the benefit of the doubt and trusted to be pro-organisational and pro-societal
• Managers cannot be assumed to prioritise their interest at an expense of the shareholders.
• Instead, agents are thought to recognise the power of cooperation and the greater utalitarian utility that it yields

Question 13

How do agents (agency theory) differ from stewards? (stewardship theory)?

Answer 13

Agents: are motivated by lower, economic needs; are self-serving; prioritise short-term objectives
Management philosophy: control and cost

Stewards: motivated by higher order concerns; want to collaborate with society; prioritise long-term visions
Management philosophy: trust and performance