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Corporate governance - What are the arguments for and against agency theory as a basis for understanding corporate governance?

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  1. Introduction.
  2. Agency theory.
  3. Managers bear the entire cost of failing to pursue their own goals.
  4. The agency costs.
  5. Two broad approaches to remedying agency problems.
  6. Conclusion.
  7. Bibliography.

Corporate governance and the theory of the firm are two of the fastest growing topics in modern economic theory. Berle and Means argued that modern corporations were so dependent upon professional managers that a managerial economy had emerged, characterized by the separation of ownership from control in corporations. The managers decided upon the running of the corporation whilst the shareholders, though they were the owners, were only entitled to receive cash flows. This leads to potential conflicts between the interests of the shareholders and those of the management. Following these two pioneering works, significant contributions have since been made in the areas of property rights theory (Hart and Moore, 1990), agency theory (Jensen and Meckling, 1976), the theory of incomplete contracts (Williamson, 1985), and transactions cost theory (Williamson, 1985). All these theories contribute from different angles to an understanding of the issues of corporate governance, and fundamentally affect our thinking about what is a firm and in whose interests the firm is governed.

[...] It is argued here that the reliance upon agency theory as a mechanism for managing a business is one of the problems which leads to the excesses referred to at the start of this article. It is therefore argued that the foundations of corporate governance in this environment are problematic. Bibliography: 1. Alchian, Armen and Harold Demsetz (1972), 'Production, Information Costs, and Economic Organisation', American Economic Review 62, 777- Berle, Adolfand Gardiner Means (1932), the Modern Corporation and Private Property, New York, Macmillan Hart, Oliverand John Moore (1990), 'Property Rights and the Nature of the Firm', Journal of Political Economy98, 1119- Himmelberg, C.P., R.G. [...]


[...] To ensure the agent works properly for the principal, the principal has to incur extra costs (non- pecuniary as well as pecuniary) - these are called the agency costs. Jensen and Meckling (p. 308) listed the agency costs as the sum of: 1. the monitoring expenditures of the principal; 2. the bonding expenditures by the agent, and 3. The residual loss The residual loss is the reduction in the value of the firm that comes about when the entrepreneur dilutes his ownership. [...]

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