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What issue does agency theory examine?

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Quick Answer

Agency theory examines the relationships between agents, such as shareholders and principals or the executives who manage a company's holdings. It focuses on the problems that arise when the two encounter conflicts of interests and how to solve these problems. The theory states that agents act in their own best interests unless given incentives to do otherwise, according to Accounting, Financial and Tax.

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Full Answer

Specifically, agency theory focuses on different attitudes towards risk between the principal and the agent and the conflicts that occur when the goals and motivations of the two are at odds, as explained by Investopedia.

The theory also explores the problems that arise in different financial situations where managers of a stock fund own 100 percent of the equity or are part owner and manger of the fund and an asymmetric information problem when a executive agent possess more information about an investment than the principal stockholders.

The theory argues that an owner/manager will act differently than one who owns 100 percent of the equity. A given example is giving a manager discretion over a influx of cash. The assertion is that a manager will use any money left over after an investment for the principal to choose funds that benefit the individual instead of the entity. It suggests that a contract between the principal and the agent include incentives to prevent this, an example being profit sharing.

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