Lecture 4 (Agency theory) Flashcards
Agency theory, what it’s about?
defining the best reward structure in the context of incomplete information & conflicting interests
What are agency relationships
relationships where there is a contract under which the principal engages the agent. The agent makes decisions on behalf of the principal.
Agency theory assumptions
agents are self-interested and opportunistic
What does agency theory assumptions lead to?
Leads to moral hazard problems
On which situations agency theory focuses on?
The theory focuses on situations where the principal and the agent have conflicting interests, and has to bear agency costs.
Positive theory of agency meaning
Separation of ownership and control. Owned by many small stockholders and controlled by managers
On-the-job consumption meaning
Agency loss when agents use company funds to make themselves better off
What are Three governance mechanisms may reduce agency costs
- Market pressures (trying to beat the competitors in the market, if not succesful it shows that manager is doing a poor job)
- Outcome-based incentives (reward based on performance)
- Information enhancing systems (bonding and monitoring)
Monitoring meaning
observing the behaviour and performance of agents
Bonding meaning
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).
Two types of contracts to structure agent’s reward
-Performance-based contract (key is result)
-Behaviour-based contract (key is effort)
When behaviour based contract is efficient?
Situations when there are complete information
How is the firm viewed as in positive agency theory?
positive theory of agency, the firm is viewed as a nexus of contracts
main research questions of the positive agency theory
how do contracts affect the behaviour of participants and why do we observe certain organizational forms in the real world?
Main research question of the theory of principal and agent
central question is how should the principal design the agent’s reward structure
entrepreneurial firm meaning
firm that is owned and managed by the same person
Team production meaning
situation in which two or more people can produce more when they are
working together than when they are working separately
Shirking meaning
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)
Theory of shirking rests on two assumptions, which are:
- there is team production;
- monitoring by someone specializing in that function can reduce shirking.
Decision process steps in agency theory:
- initiation (generation of proposals for resource utilization and structuring of contracts)
- ratification (choosing which of the initiatives is to be implemented)
- implementation (execution of the ratified decisions)
- monitoring (measurement of the performance of decision agents
and implementation of rewards)
Forcing contract
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
Decision management includes:
Initiation and implementation
Decision control includes:
ratification
and monitoring
