Q1. In 750 words offer a detailed explanation of the role ‘agency theory’ plays in
strategic management in organisations. Use both strategic management theory and
organisational examples to support you answer.
Agency theory is one of the most prominent theoretical perspectives in business and
management research (Payne & Petrenko, 2019). This is a management method in which
one-person (agent) acts on behalf of another person (principal) to perform some service
which involves promoting the principal’s goals (Eisenhardt, 1989; Hill & Jones, 1992).
This is, the agent acts on its interest and the principal’s interest in the organization
(Eisenhardt, 1989), however, the balance of these interest should be combined in order to
achieve the organization’s corporate objectives through the agency theory. (Payne &
Petrenko, 2019)
Eisenhardt, (1989) believes that the agency theory in strategic management is essential
because the actions chosen by a specific individual will affect several parties in the
organization, therefore, the role of agents in strategy formulation and the entire strategic
process cannot be underestimated (Bendickson et al., 2016). Nonetheless, the agency
theory argues that the agent’s interest may differ from the principal’s goals, thus a
problem will arise. Essentially, this problem occurs since the principal-agent relationship
has not been optimized because of the different interest of the parties involve (Payne &
Petrenko, 2019)
Agarwal et al., (2014) discussed that the existence of a contract would possibly prevent
the rise of the principal-agent problem. For example, the investor and the manager would
sign a contract specifying in advance how the funds will be managed by the manager and
how the income will be distributed. In other words, investors can use contracts to perfectly
adjust their interest and manager’s goals to be consistent with their own. However, a
complete contract is not feasible because it is impossible to foresee all future
contingencies. This incompleteness of the contract means that investor and managers will
have to allocate the control rights in some way, where right decisions can be taken under
unforeseen circumstance or under conditions not covered by the contract (Agarwal et al.,
2014)
Eisenhardt (1989) pointed out that the agency theory is used as a theoretical framework
for structure and contract management. Therefore, it explains the behaviour of the
relationship between the principal and agent in the management performance contract.
1
, Snyman & Kruger, (2004) added that agency theory is present at all levels of the strategic
management process. They believed that from corporate strategy to operational strategy,
the goals designed at all these levels must be supervised by agents or managers in order
for the organization to achieve the management goals. Hence, organizations must set
objective at all strategic hierarchy levels. Bendickson et al., (2016) emphasized that to
achieve these goals, managers must collaborate as agents and subordinates. The strategic
management plan requires senior managers to provide clear and visible support for the
plan. Without the support of managers, the integration between employees and
organizational goals will not develop.
The Enron scandal is a special example of the lack of integration between agents and
principals in the strategic management process. Enron was one of the largest companies
in the United States. Despite being a multi-billion-dollar company, Enron was still losing
money. The company has also begun to accumulate large amounts of debt, so, fearing a
drop in stock prices, Enron's management team used tricky accounts to misrepresent
losses, covering them up. Enron's directors have a legal obligation to protect and promote
the interests of investors. However, the company’s board of directors failed to perform its
supervisory duties over the company and oversight responsibilities, which led the
company to venture into risky illegal activities. The company got into trouble after an
accounting scandal that caused billions of dollars in losses. (Investopedia, 2020)
This means that at each level of the strategy development hierarchy, there must be an
agent responsible for representing other stakeholders at other levels. Therefore, it can be
said that a proper understanding between the principal and the agent should be established
in order to assist each other, thus the organization can effectively and efficiently achieve
its goals.
References
Agarwal, S., Goel, R., & Kumar Vashishtha, P. (2014). A Literature Review of Agency
Theory ECONOMICS.
Bendickson, J., Muldoon, J., Liguori, E. W., & Davis, P. E. (2016). Agency theory:
background and epistemology. Journal of Management History, 22(4), 437–449.
https://doi.org/10.1108/JMH-06-2016-0028
Eisenhardt, K. M. (1989). Agency Theory: An Assessment and Review. In Academy ol
2
strategic management in organisations. Use both strategic management theory and
organisational examples to support you answer.
Agency theory is one of the most prominent theoretical perspectives in business and
management research (Payne & Petrenko, 2019). This is a management method in which
one-person (agent) acts on behalf of another person (principal) to perform some service
which involves promoting the principal’s goals (Eisenhardt, 1989; Hill & Jones, 1992).
This is, the agent acts on its interest and the principal’s interest in the organization
(Eisenhardt, 1989), however, the balance of these interest should be combined in order to
achieve the organization’s corporate objectives through the agency theory. (Payne &
Petrenko, 2019)
Eisenhardt, (1989) believes that the agency theory in strategic management is essential
because the actions chosen by a specific individual will affect several parties in the
organization, therefore, the role of agents in strategy formulation and the entire strategic
process cannot be underestimated (Bendickson et al., 2016). Nonetheless, the agency
theory argues that the agent’s interest may differ from the principal’s goals, thus a
problem will arise. Essentially, this problem occurs since the principal-agent relationship
has not been optimized because of the different interest of the parties involve (Payne &
Petrenko, 2019)
Agarwal et al., (2014) discussed that the existence of a contract would possibly prevent
the rise of the principal-agent problem. For example, the investor and the manager would
sign a contract specifying in advance how the funds will be managed by the manager and
how the income will be distributed. In other words, investors can use contracts to perfectly
adjust their interest and manager’s goals to be consistent with their own. However, a
complete contract is not feasible because it is impossible to foresee all future
contingencies. This incompleteness of the contract means that investor and managers will
have to allocate the control rights in some way, where right decisions can be taken under
unforeseen circumstance or under conditions not covered by the contract (Agarwal et al.,
2014)
Eisenhardt (1989) pointed out that the agency theory is used as a theoretical framework
for structure and contract management. Therefore, it explains the behaviour of the
relationship between the principal and agent in the management performance contract.
1
, Snyman & Kruger, (2004) added that agency theory is present at all levels of the strategic
management process. They believed that from corporate strategy to operational strategy,
the goals designed at all these levels must be supervised by agents or managers in order
for the organization to achieve the management goals. Hence, organizations must set
objective at all strategic hierarchy levels. Bendickson et al., (2016) emphasized that to
achieve these goals, managers must collaborate as agents and subordinates. The strategic
management plan requires senior managers to provide clear and visible support for the
plan. Without the support of managers, the integration between employees and
organizational goals will not develop.
The Enron scandal is a special example of the lack of integration between agents and
principals in the strategic management process. Enron was one of the largest companies
in the United States. Despite being a multi-billion-dollar company, Enron was still losing
money. The company has also begun to accumulate large amounts of debt, so, fearing a
drop in stock prices, Enron's management team used tricky accounts to misrepresent
losses, covering them up. Enron's directors have a legal obligation to protect and promote
the interests of investors. However, the company’s board of directors failed to perform its
supervisory duties over the company and oversight responsibilities, which led the
company to venture into risky illegal activities. The company got into trouble after an
accounting scandal that caused billions of dollars in losses. (Investopedia, 2020)
This means that at each level of the strategy development hierarchy, there must be an
agent responsible for representing other stakeholders at other levels. Therefore, it can be
said that a proper understanding between the principal and the agent should be established
in order to assist each other, thus the organization can effectively and efficiently achieve
its goals.
References
Agarwal, S., Goel, R., & Kumar Vashishtha, P. (2014). A Literature Review of Agency
Theory ECONOMICS.
Bendickson, J., Muldoon, J., Liguori, E. W., & Davis, P. E. (2016). Agency theory:
background and epistemology. Journal of Management History, 22(4), 437–449.
https://doi.org/10.1108/JMH-06-2016-0028
Eisenhardt, K. M. (1989). Agency Theory: An Assessment and Review. In Academy ol
2
