Agency Theory in Management

17 August 2007 at 2:12 am 11 comments

| Nicolai Foss |

I believe that agency theory is one of the most informative, useful, and interesting theories coming out of economics ever. It is surely also one of the most influential econ theories in management. Agency theory is, however, fundamentally complicated, and difficult to teach. I find it impossible to teach without making use of at least some math (specifically, simple versions of the linear model). In particular, grasping the role that the risk premium plays in the theory, and, in this connection, what is really the source of the agency loss, is often very difficult  for students.

However, not only students but also management academics have difficulties understanding the theory.

Here are some examples of common mistakes in the management literature:

  1. Conflating moral hazard and opportunism (e.g., Anurag Sharma’s 1997 paper in AMR). This is one of the smaller sins and many economists have sinned here as well, thinking of moral hazard as “ex ante opportunism.” However, opportunism is tied to recontracting which moral hazard isn’t.
  2. Bounded rationality and asymmetric information. Agency theory emphatically does not make the assumption of bounded rationality. Contracting is not imperfect in this theory because of bounded rationality but because of asymmetric information. Eisenhardt’s heavily cited (1,325 hits on google scholar) 1989 paper makes this mistake.
  3. The perspective of the theory. Much critique of agency theory, e.g., by Charles Perrow, takes its starting point in the claim that it takes the perspective of the principal. It does not. It is a theory about joint value maximization and what self-interested parties can do to remedy obstacles to such maximization. It takes an agent perspective as much as it takes a principal perspective. What critics may have in mind is the assumption, mainly motivated by analytical convenience, that the principal has all the bargaining power.
  4. Types of agency theory. Some management writers, such as Nilakant and Rao (1994, Org Studies), claim a distinction between “positivist agency theory” (largely verbal, mainly concerned with corporate governance) and formal agency theory (think Bengt Holmström). The distinction is bogus. While there may be more or less formal contributions to agency theory the analytical core is the same.

Entry filed under: - Foss -, Management Theory, New Institutional Economics. Tags: .

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11 Comments Add your own

  • 1. Richard O. Hammer  |  18 August 2007 at 3:07 am

    I have gained some education in economics, but I am ignorant of agency theory. Can you recommend a text which would introduce me to agency theory?

  • 2. Nicolai Foss  |  18 August 2007 at 3:12 am

    Hi Richard, Georg Hendrikse 2003 Economics and Management of Organizations has a nice treatment of agency theory (chpts 5 & 6). Joe Mahoney’s Economic Foundations of Strategy from 2004 can also be recommended.

  • 3. daniel schut  |  21 August 2007 at 4:10 pm

    and interesting, non-economic, non-technical introduction to “the principle-agent-framework” is by a man called Jan-Erik Lane (I forgot the title). It’s interesting because he ties the PA-framework in to more broader ideas of politics and law.

    Then again, I have never read a better description of the basics then Jensen and Meckling’s “theory of the firm”

  • 4. Elen  |  11 October 2007 at 11:39 am

    I have to prepare a project on Agency Theory and i would really be grateful if you could sent me a text or a link or anything you think will be useful to understand what this theory is all about.
    Thank you.

  • 5. samir ahmed  |  22 October 2007 at 9:58 am

    i have a presentation on Agency theory coming in near future. i would be appriciative, if you could email me any information and/or any weblink that might think will help me towards my presentaion.

    Many thanks.

  • 6. irma  |  30 October 2007 at 11:18 pm

    i have a tast bout whats d impact of agency theory? can u help me………..plz……….

  • 7. Charles Berkoh  |  20 November 2007 at 3:55 am

    The Agency theory is so fascinating and it is very relevant for small partnership firms where one partner is in charge of the of the firm on day-to-day basis. To what extent does corporate laws of a country influence the theory. More information on this to me can be very helpful.

    Thanks for your site

  • 8. book of Lane, Jan-Erik.  |  4 January 2009 at 10:40 pm

    Lane, Jan-Erik.
    Title Public administration and public management : the principal-agent perspective / Jan-Erik Lane.
    Published London ; New York : Routledge, 2005.

  • 9. Genefer  |  20 February 2010 at 6:46 am

    i have a presentation on theory agency in management of organisatios, can you pls e-mail me the informative, useful, and interesting theories coming out of economics ever

  • 10. farida saleem  |  21 June 2010 at 1:25 am

    i am working on developing a link between agency theory and the adoption of environmental friendly practices by organizations if any one has info about that plz email me

  • 11. David Hoopes  |  23 June 2010 at 2:19 am

    Funny how many people want help with this. Seems different than most other theories that pop up. Not that hard to find agency theory papers……

    Best of luck all. lol

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