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What is meant by agency theory?
Give two examples where agency theory is applied?
1: Agency Theory explains
how to best organize relationships in which one party determines the work while
another party does the work. In this relationship, the principal hires
an agent to do the work, or to perform a task the principal is unable or
unwilling to do. For example, in corporations, the principals are the
shareholders of a company, delegating to the agent i.e . the management of the company, to perform tasks on their
behalf. Agency theory assumes both the principal and the agent are
motivated by self-interest. This assumption of self-interest dooms agency
theory to inevitable inherent conflicts. Thus, if both parties are
motivated by self-interest, agents are likely to pursue self-interested
objectives that deviate and even conflict with the goals of the
principal. Yet, agents are supposed to act in the sole interest of their
principals. To determine when an
agent does (and does not) act in their principals interest, the standard of
Agency Loss has become commonly used. Agency loss is the difference
between the best possible outcome for the principal and the consequences of the
acts of the agent. For instance, when an agent acts consistently with the
principals interests, agency loss is zero. The more an agents acts deviate
from the principals interests, the more agency loss increases. When an agent
acts entirely in her own self interest, against the interest of the principal,
then agency loss becomes high. 2: Examples The first is that the principal…

and the agent share common interests .
Essentially, this means that both the principal and the agent desire the same
outcome. The second is that the principal is knowledgeable about the consequences of the
agents activities. In other words, the principal knows whether
their agents actions serve in the principals best interest. If either of these statements is false, it follows that agency
loss is therefore, likely to arise. One objection to agency
theory is that it relies on an assumption of self-interested agents who seek
to maximize personal economic wealth (Bruce et al., 2005). The challenge is
therefore, to get agents to either set aside their self-interest, or work in a
way in which they may maximize their personal wealth while still maximizing the
wealth of the principal. Thus, a standard of agency duty and action is
necessary, not because agents are universally selfish, but because the
potential for differences between the principals and the agents interests
exists.

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