Question

Explain "The agency Theory", then explain its strengths and weaknesses.

Answer 1

Agency theory basically in practice to resolve issues between principal \s or we can say real owners and their agents. Principals are the person who basically put their money or resources in business and agents are the person who are appointed by those principals to act on their behalf i.e. to take big or all decisions related to business. e.g. in case of a company shareholders are real business owner (ie. principal) and managers CEOs CFOs are agents who are working with the help of the resources/ funds of shareholders. Agency cost is basically referred to cost that wsa incurred because business is managed by agents instead of principal. It can be due to difference in risk taking ability of principal and agents; difference in business decisions taken by agents etc. e.g. agents may go for a risky project which principal may not feel so positive for the same as because of their risk taking ability. To reduce this cost agency theory concept is introduced. With the help of this theory, business house try to reduce this agency cost. They do this by making agent indirect owners of business i.e. by providing company's share or profit percentage or linking their promotion with company's performance. The basic strength and weaknesses of this theory are as follows:

Strength: Increased principal/ owners belief in working of company; leads to high level of obedience and discipline in organisation working;

Weakness: The theory is basically qualitative or we can say behavioral instead of quantitative therefore difficult to justify acts in case some one found guilty. Therefore details and justifications are not that strong or concrete.