Lecture 4 (Agency theory)

Question 1

Agency theory, what it’s about?

Answer 1

defining the best reward structure in the context of incomplete information & conflicting interests

Question 2

What are agency relationships

Answer 2

relationships where there is a contract under which the principal engages the agent. The agent makes decisions on behalf of the principal.

Question 3

Agency theory assumptions

Answer 3

agents are self-interested and opportunistic

Question 4

What does agency theory assumptions lead to?

Answer 4

Leads to moral hazard problems

Question 5

On which situations agency theory focuses on?

Answer 5

The theory focuses on situations where the principal and the agent have conflicting interests, and has to bear agency costs.

Question 6

Positive theory of agency meaning

Answer 6

Separation of ownership and control. Owned by many small stockholders and controlled by managers

Question 7

On-the-job consumption meaning

Answer 7

Agency loss when agents use company funds to make themselves better off

Question 8

What are Three governance mechanisms may reduce agency costs

Answer 8

1. Market pressures (trying to beat the competitors in the market, if not succesful it shows that manager is doing a poor job)
2. Outcome-based incentives (reward based on performance)
3. Information enhancing systems (bonding and monitoring)

Question 9

Monitoring meaning

Answer 9

observing the behaviour and performance of agents

Question 10

Bonding meaning

Answer 10

Arrangements that penalise agents (managers) for acting in ways that violate the interests of principals (shareholders) or reward them for achieving principal’s goals (signalling).

Question 11

Two types of contracts to structure agent’s reward

Answer 11

-Performance-based contract (key is result)
-Behaviour-based contract (key is effort)

Question 12

When behaviour based contract is efficient?

Answer 12

Situations when there are complete information

Question 13

How is the firm viewed as in positive agency theory?

Answer 13

positive theory of agency, the firm is viewed as a nexus of contracts

Question 14

main research questions of the positive agency theory

Answer 14

how do contracts affect the behaviour of participants and why do we observe certain organizational forms in the real world?

Question 15

Main research question of the theory of principal and agent

Answer 15

central question is how should the principal design the agent’s reward structure

Question 16

entrepreneurial firm meaning

Answer 16

firm that is owned and managed by the same person

Question 17

Team production meaning

Answer 17

situation in which two or more people can produce more when they are
working together than when they are working separately

Question 18

Shirking meaning

Answer 18

People working in a team and sharing the proceeds of their work will put in a lower level of effort than people who are self-employed (avoiding work duties)

Question 19

Theory of shirking rests on two assumptions, which are:

Answer 19

• there is team production;
• monitoring by someone specializing in that function can reduce shirking.

Question 20

Decision process steps in agency theory:

Answer 20

1. initiation (generation of proposals for resource utilization and structuring of contracts)
2. ratification (choosing which of the initiatives is to be implemented)
3. implementation (execution of the ratified decisions)
4. monitoring (measurement of the performance of decision agents
   and implementation of rewards)

Question 21

Forcing contract

Answer 21

Principal promises to pay an amount e0 if the agent’s level of effort is at least e0 and to pay nothing if the agent’s level of effort is smaller than e0

Question 22

Decision management includes:

Answer 22

Initiation and implementation

Question 23

Decision control includes:

Answer 23

ratification
and monitoring