The Nexus between agency theory and corporate governance Essay

The Nexus between agency theory and corporate governance - Essay Example This essay tries to explain the agency theory and corporate governance in the present day environment. Economists recently are more diverted to the phenomenon of organisation. The recently formulated organisation theory agency theory is different from the ones which existed in the past. Fama (1980) focused at the possible managerial labour market to restrain and guide individual decision-making expedience. In essence all these various statements are construed based on a few simple assumptions. These assumptions according to Donaldson (1990) are construed as a 'theory of interest, motivation and compliance'."Specifically, agency theory is directed at the ubiquitous relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory attempts to describe this relationship using the metaphor of a contract" (Eisenhardt, 1989: p58).The neoclassical school analyses the individual who tries to maximise or in the least to satisfy their utility between work and time off. This combination of assumed independence and selfish enthusiasm that is problematic within the relationship of agent and principal. In terms of corporate governance the shareholder is the principal. The problem arises due to the separation of ownership and control.According to Jill Solomon (2007) the failure to corporate governance and corporate crumple can take place in the firmest company. It is possible to seduce the Investors, creditors and employees through a company's repute and achievement. This can even throw caution to the wind. If the agents of economic accountability were intellectuals, as it is a must based on the economic and finance theory, this form of sightlessness could never occur. But the problem is that it does happen, investors behave rationally not always, and the factors of human behaviour and psychology are tricky to fit in a finance framework or an economic hypothesis. Cases of irrational behaviour in the UK during the 198 0s were that of Polly Peck and Coloroll. This was a case when the capitalist found very important information relating to contingent liabilities were missing from the accounts of these companies (Smith et all, 1992). Differences between managers and shareowners Agency theory brings up a basic problem in organizations and that is self-interested conduct. The managers of a corporation normally have their own goals which often cross roads with the proprietor's goal of maximising shareholder wealth. As it is the shareholders who give power to the managers to manage the firm's wealth, a prospective difference of opinion arises between the two groups. Agency Cost How does the agent that is the company directors serve the principal that is the shareholders is the question. The solution lies in accepting certain agency costs. These costs involve either in producing incentives or approve which adjust executive egoism with the concerns of shareholders. Or else they may be involved in supervising executive behaviour in order to restrain their self-interest. This led to the development of the number of non-executives on the company boards. Also it resulted in augmented arrangement of their function and considerations of freedom, leading to reforms all over the world. The separation of the part played by the chief executive and that played by the non-executive has been made a part of this reform. The establishment of audit, compensation, and recommendations committees is actually independent non-executives appointed to assure the proper use of the incentives and also to check the performance of the executives. These internal controls