AGENCY THEORY:

Agency theory is a general term for views on the relationship among the various players in the corporate structure. These players include stockholders, creditors, directors, officers (CEOs, CFOs, CIOs, etc.), and employees.

The assumption of the theory is that although the corporation exists for the benefit of the owners, that people who are engaged by the corporation to work to achieve those objectives are less than perfectly committed to those corporate objectives. The rationale underlying this conflict is based on the perceived realities of human nature - the realities are that a person can be paid to work toward someone else's goals, but that the "agent" will not fully supress their own personal objectives. The agent's personal objectives are assumed to be the same rational economic goals that drive the owners, the maximization of their own personal wealth. The theory suggests that the conflict between the owners and the agents is inherent in the relationship, that the conflict cannot be eliminated, although it can be acknowledged.

Various practices are designed to address the conflict - the most obvious is for the owners to share their ownership with the agents. This, in effect, gives two roles to the agent, with the hope that the agents will fully embrace the objectives of the owners. Unfortunately for the "pure" owners (stockholders without any other relationship with the firm other than owning stock), sharing ownership has not proven to be effective in fully suppressing the agents' personal objectives.

Thus, other practices are instituted to address the conflict that take the form of corporate policy that constrains the agents' behavior. And while these constraints may have the effect of preventing agents from gaining the "upper hand", the constraints also dillute operational efficiency and represent a significant cost to the firm.

The concept of "stakeholders", is a term sometimes used to include every person remotely connected with the firm: stockholders, crediters, customers, employees, vendors, suppliers, and people living in proximity of corporate activity. Agency theory does not address the objectives of stakeholders - moreover, the theory suggests that the notion of stakeholders is a total fallicy.