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date: 09 December 2019

Agency Theory in Business and Management Research

Summary and Keywords

Agency theory is one the most prominent theoretical perspectives utilized in business and management research. Agency theory argues—using fundamental assumptions that agents are: (a) self-interested, (b) boundedly rational, and (c) different from principals in their goals and risk-taking preferences—that a problem occurs when one party (a principal) employs another (an agent) to make decisions and act in their stead. Essentially, the value of a principal-agent relationship is not optimized because the two contracted parties may have different interests and information is asymmetric (not equal). Agency costs are the result of principal and agent conflicts of interest and disagreements regarding actions that are taken. As such, monitoring and incentive-alignment systems are used to curb costs associated with opportunist behavior.

Agency theory is commonly utilized to understand and explain corporate governance phenomena, including executive incentive alignment, board monitoring, and control of top managers; this strand of the literature is founded in economics and represents the bulk of the research in business and management. However, other important principal-agent relationships are commonly seen in business and society, such as with politicians/voters, brokers/investors, and lawyers/clients, and have benefited from the vast stream of research that has explored the principal-agent relationship in various forms and contexts. Also, alternative theoretical perspectives have emerged to accommodate variations of the principal-agent relationship. Namely, principal-principal agency, behavioral agency, and stewardship theories are prominent alternative theories that challenge, expand, or relax the basic assumptions of the classic theory to extend our understanding of important relationships and mechanisms in business and management.

Keywords: agency, agency theory, behavioral agency, bounded rationality, conflict of interest, information asymmetry, moral hazard, principals, self-interest, stewardship

Introduction

Agency theory is one of the dominant theories of organizations and management due to its specific focus on the relationship between principal (e.g., owner) and agent (e.g., management). Essentially, agency theory seeks to better understand how to optimize the principal-agent relationship, which is problematic and potentially costly because interests, risk preferences, and utility functions are different for the two parties (Eisenhardt, 1989). In the business literature, agency theory has been applied to a wide variety of disciplines beyond economics and finance to include entrepreneurship (Arthurs & Busenitz, 2003), ethics (Davis, Payne, & McMahan, 2007), family business (Madison, Holt, Kellermanns, & Ranft, 2016), and strategic management (Kim & Mahoney, 2005), among others. The theory is commonly used to describe and explain how costs—incurred based on problems associated with the separation of ownership and management—can be assuaged in various business settings.

Agency theory has a long, rich history dating back to the formative economics-based works of Spence and Zeckhauser (1971), Ross (1973), and Jensen and Meckling (1976). Since these early works were published, scholars have studied a variety of mechanisms that help theoretically explain the market failures implicit in the earliest agency conceptions (e.g., Berle & Means, 1932/2009; Smith, 1776/1952). Scholars have also sought to provide prescriptions for “solving” the agency problem (Fama, 1980; Fama & Jensen, 1983a, 1983b; Jensen & Meckling, 1976; Mahoney, 2005). For example, creating alignment between business goals and executive compensation (e.g., bonuses, stock options, and salary) is a common method utilized to minimize agency costs and improve outcomes (Beatty & Zajac, 1994; Eisenhardt, 1989; Jensen & Murphy, 1990; Zajac & Westphal, 1994).

While some scholars have declared the agency problem to be resolved (Baker, Jensen, & Murphy, 1988; Mahoney, 2005), empirical evidence has demonstrated inconsistent findings for many of the fundamental arguments of agency theory. For example, the relationships between CEO pay and market performance (Jensen & Murphy, 1990), pay variance and financial performance (Frydman & Jenter, 2010; Tosi, Werner, Katz, & Gómez-Mejía, 2000), and managerial incentives and risk taking (Beatty & Zajac, 1994; Bloom & Milkovich, 1998; Lewellen, 2006; Sanders & Hambrick, 2007) have demonstrated mixed findings relative to agency prescriptions. Over time, the extent of mixed findings—despite logically grounded arguments that are “well documented in the world of experience” (Mahoney, 2005, p. 139)—has led scholars to either reject agency theory outright (e.g., Perrow, 1986) or call for theory modifications, which generally include relaxing or altering assumptions (Kiser, 1999; Mitnick, 1992; Pepper & Gore, 2015; Shapiro, 2005; Tosi & Gómez-Mejía, 1989; Zajac & Westphal, 1994). In effect, the consistently expressed concerns regarding the overall usefulness and accuracy of the classic agency assumptions and arguments have promoted an extensive and diverse literature that is both critical and supportive of agency theory (Heath, 2009; Pouryousefi & Frooman, 2017).

This article has three primary purposes. First, it provides a brief overview of agency theory, including its history, foundational concepts, and key assumptions. Second, it discusses some of the key criticisms of agency theory; critics generally question the validity and usefulness of the theory due to its overly simplistic, unrealistic, and rigid assumptions. Third, it highlights recent modifications and extensions of agency theory that attempt to be more flexible, robust, and representative of actual relationships found in practice. Overall, the main goal of this article is to inform readers about agency theory and extend the conversation to provide a better collective understanding of relevant business phenomena. It is acknowledged, however, that the extant literature is too massive and multidisciplinary to be covered in a single treatise. Therefore, it is suggested that this article serve as a starting point for a more extensive exploration into this important theory.

An Overview of Agency Theory

Among the many published works on agency theory, the Jensen and Meckling (1976) landmark paper is the most highly cited. However, the origins of agency theory—as Jensen and Meckling acknowledge in their epigraph—can be traced to Adam Smith (1776/1952), who recognized that managers cannot be expected to watch over others’ capital with the same vigilance as their own. Despite this initial discovery, the core concept of agency in business management contexts did not see significant development until Berle and Means (1932/2009, p. 7) highlighted how the separation of ownership and management “produces a condition where the interests of owner and of ultimate manager may, and often do, diverge, and where many of the checks which formerly operated to limit the use of power disappear.” In their seminal work, Berle and Means (1932/2009) were the first to state that personal gains can be a big motivator for agency behaviors, although the agency term was yet to be coined. Further, they acknowledged issues of information asymmetry—defined as unequal knowledge across parties—by stating, “the stockholder is therefore left as a matter of law with little more than a loose expectation that a group of men, under a nominal duty to run the enterprise for his benefit and that of others like him, will actually observe this obligation” (Berle & Means, 1932/2009, p. 244).

Several decades after Berle and Means (1932/2009) outlined the central tenets of agency problems, scholars in economics and political science—working independently (Mitnick, 2006)—developed a more formal theory of agency (Shapiro, 2005). While Ross (1973) should be largely credited with originating economic agency theory (Mitnick, 2006; Shapiro, 2005), Jensen and Meckling (1976) applied the concepts to the theory of the firm, which started an extensive stream of theoretical and empirical work in the broader business domain. As economists continued their work on general agency theory, researchers in management adopted this approach to study more specific agency issues in the contexts of firms and corporate governance. By the end of the 20th century, agency theory had become a major theoretical perspective, perhaps most influencing the strategic management field of study due to its applicability to executives as manager-agents of shareholders of large corporations (Bergh, Ketchen, Orlandi, Heugens, & Boyd, 2018; Eisenhardt, 1989; Mahoney, 2005).

More recently, agency theory has seen some theoretical development (e.g., Bosse & Phillips, 2016; Pepper & Gore, 2015) and been empirically applied to contexts beyond traditional corporate governance structures (e.g., Drover, Wood, & Payne, 2014; Gómez-Mejía, Haynes, Núñez-Nickel, Jacobson, & Moyano-Fuentes, 2007). However, much of the agency research is still based on the classic theoretical arguments and assumptions that have been in place for decades. While this article briefly discusses these foundational tenets, the reader is referred to Eisenhardt (1989), Shapiro (2005), and Dalton, Hitt, Certo, and Dalton (2007) as seminal works that provide in-depth overviews of the theory and its applications.

Key Arguments: Principal-Agent Problems and Costs

The agency relationship is a ubiquitous feature of economic life (Arrow, 1985) and exists in many contexts, such as between politicians/voters, brokers/investors, lawyers/clients, and even editors and authors of an invited article (Shapiro, 2005). Within business and management, the relationship most commonly considered from an agency perspective is between the manager(s) and owner(s) of the firm. Generally, the principal (i.e., the owner) hires or contracts work to the agent (i.e., the manager), who is then expected to act according to the agreement and in the best interests of the principal (Jensen & Meckling, 1976; Williamson, 1990).

The principal-agent relationship is argued to result in two key problems that are costly and lead to suboptimal outcomes for the firm: (a) adverse selection, and (b) moral hazard (Amit, Brander, & Zott, 1998; Eisenhardt, 1989). An adverse selection problem exists when the agent lacks, or otherwise fails to demonstrate, the skills or capabilities necessary to competently meet the expectations of the principal. While the discrepancy between competencies and expectations may be based on erroneous, incomplete, or falsified information given and received during contracting, the underlying issue is one of making a poor hiring or contracting decision where the agent does not or cannot meet expectations. Moral hazard, on the other hand, refers to opportunistic behavior by the agent in the scope of the employment contract; this includes shirking and free-riding behaviors (Eisenhardt, 1989). Such behavior was first described as “soldiering” by Frederick Taylor (1911); it is where employees knew their true ability and how to work faster and more efficiently, but concealed this information from management to avoid more stringent job requirements. The main issue with moral hazard is that agents are interested in achieving acceptable outcomes through minimum effort, while the principal is interested in maximizing agent efforts (Arrow, 1985).

Agency theory generally prescribes addressing adverse selection and moral hazard problems through pre- and post-contractual mechanisms. Pre-contractual mechanisms, largely targeting the reduction of adverse selection, include extensive interviews, reference checks, and other information-gathering techniques that can help provide more complete knowledge about a potential agent (i.e., manager). Post-contractual mechanisms, on the other hand, represent the various ways to monitor or incentivize behaviors, after an agent is hired, to reduce the problem of moral hazard (Mahoney, 2005). Monitoring refers to structures or processes that allow the principal to oversee and assess actual behaviors; most commonly, the board of directors is the mechanism through which managers are monitored. Incentive alignment, alternatively, attempts to shift risk to the agent by tying outcomes of behaviors to compensation (Davis, Schoorman, & Donaldson, 1997; Walsh & Seward, 1990). For example, stock options and bonus structures are commonly used to align incentives. Both types of mechanisms may be used separately or in tandem, as substitutes or complements (Rediker & Seth, 1995), but these mechanisms come with costs to the firm that can potentially exceed those of the unmitigated agency problems or produce other undesirable outcomes (Bosse & Phillips, 2016; Harris & Bromily, 2007). As noted, the value of monitoring and incentive-alignment mechanisms in reducing costs have produced mixed empirical findings (e.g., Dalton et al., 2007).

Jensen and Meckling (1976) were the first to use the term “agency costs,” which they argue are “as real as any other costs” found in the firm (p. 72). They define agency costs as the sum of (a) monitoring expenditures by the principal, (b) the bonding expenditures by the agent, and (c) the residual loss. Monitoring costs are assumed to be imposed on the principals and include everything that is associated with principals having to monitor agency behavior. A large portion of monitoring costs involve attempts to reduce information asymmetry—commonly viewed as “hidden information”—and its associated problems of moral hazard and adverse selection (Bergh et al., 2018). For instance, mechanisms used to mitigate information asymmetry include financial monitoring, expenditures associated with board of directors (as a monitoring mechanism), and internal auditing activities. Bonding costs are the opposite of monitoring costs in the sense that they are incurred by the agent. Bonding costs are expenditures made by the agent to reassure principals that they will act in their best interest. Examples of this type of cost include contractual guarantees and formal limitations on managerial power (Jensen & Meckling, 1976; Mahoney, 2005).

The third type of agency costs is residual loss. While monitoring and bonding costs are incurred to account for and resolve the principal-agent differences and asymmetries, residual loss is due to unresolved conflicts of interests and information asymmetries between the parties; this is a very expansive category that can include almost any cost that comes as a result of the agency relationship—other than those incurred through monitoring or bonding mechanisms (Jensen & Meckling, 1976; Mahoney, 2005). However, monitoring and bonding can be used to reduce overall residual loss and it is this trade-off that represents the primary challenge for dealing with agency costs (Eisenhardt, 1989). As Makadok (2001) argues, finding solutions to the various agency problems is costly in and of itself, but it also diverts attention and resources away from other firm activities.

Overall, Jensen (1983, p. 331) argues that agency costs represent “the sum of the costs of structuring, bonding and monitoring contracts between agents . . . [which] . . . also include the costs stemming from the fact that it does not pay to enforce all contracts perfectly.” Costs, therefore, are a central component of the theory because minimizing costs through an efficient contractual agreement between the two parties lies at the heart of the theory’s prescriptions. In other words, principal-agent costs can be reduced if correct mechanisms that efficiently monitor, reward, and control agent behaviors can be implemented (Daily, Dalton, & Cannella, 2003; Eisenhardt, 1989).

Criticisms of Assumptions

While agency theory is parsimonious and readily applicable to many business phenomena and contexts, particularly the corporate owner-manager relationship, both the logical and practical prescriptions of the theory are strongly tied to some key assumptions about human behavior. These assumptions, while important to understanding the arguments of the theory, are applied more or less stringently across various studies and across research disciplines. Therefore, it is important to consider the various assumptions that have been utilized, and in what situations they have been applied, to better understand the nature of the extant criticisms, as well as the conceptual developments currently being made in research. Essentially, critics claim that the assumptions narrow the theory so that various contingencies are discounted to such an extent that the theory does not adequately reflect reality (Wright, Mukherji, & Kroll, 2001).

Agency theory generally assumes that actors are: (a) self-interested, (b) boundedly rational, and (c) differ in goals and risk preferences (Eisenhardt, 1989). Fundamentally, these assumptions contend that individuals (both principals and agents) seek to optimize their own economic utility within the business context (Davis et al., 1997). In other words, agents and principals are expected to behave rationally in their efforts to maximize their value appropriation from the contractual relationship. This means there is likely a divergence in actor interests, which will lead to the problems and costs already discussed. In general, the argument is that while owners are primarily interested in increasing their personal wealth by earning returns on their investments in the firm, managers are more interested in the benefits they receive from their employment such as salary, bonuses, prestige, power, and perks. Self-interested activities are reflected in managerial choices regarding work effort, risk tolerance, and time horizons (Jensen, 1994).

While assumptions of self-interest, bounded rationality, and divergent preferences are fundamental to the theory, many scholars take issue with such a narrow assessment of human behavior, particularly regarding its negative views of people and morality. According to critics of agency theory, focus on the self-interested nature of human behavior downplays other motives such as altruism and intrinsic motivation (Davis et al., 1997). In particular, it is important to consider the distinction between self-interested behavior and opportunism (Jensen, 1994; Jensen & Meckling, 1994). Gómez-Mejía, Wiseman, and Dykes (2005, p. 1508; emphasis in original) quote the definition of opportunism by McKechnie (1979) as “the adaptation of one’s actions to circumstances in order to further one’s immediate interests, without regard for basic principles or consequences.” Gómez-Mejía et al. (2005) argue that the emphasized (i.e., italicized) part of the definition is what differentiates opportunism from rational self-interest. Similarly, Williamson (1981), in his discussions of transaction costs economics theory, defines opportunism as pursuing self-interest with “guile.” The key to this definition of self-interest is that it does not necessarily manifest itself in opportunism, which is commonly assumed in applications of agency theory. Rather, self-interest does not have to run counter to the interests of other parties nor does it need to involve immoral or unethical activities. Rather, self-interest may be best accomplished in ways that improve the lot of all parties, such as through cooperation. Also, opportunism is typically and implicitly related only to the agent, rather than to both agent and the principal (Perrow, 1986; Shapiro, 2005). This also suggests limitations to the theory’s representation of reality.

Another major assumption of agency theory is information asymmetry (Arrow, 1985; Bergh et al., 2018; Levinthal, 1988; Mahoney, 2005; Pratt & Zeckhauser, 1985), which is based on the fundamental supposition that “different people know different things” (Stiglitz, 2002, p. 469). In the extant literature, principals are assumed to have limited, different, or incomplete knowledge of the abilities, expertise, or intentions of the individual agents. As such, it is not possible for a principal to know, ex ante, the exact level of value the agent will provide because an agent’s work is not always readily observable, and outcomes are not solely determined by the agent’s efforts (Levinthal, 1988). Indeed, it is because the principal recognizes that incomplete or hidden information exists—allowing for opportunistic behavior—that pre- and post-contractual mechanisms (i.e., monitoring and bonding mechanisms) are put into place (Arrow, 1985; Eisenhardt, 1989; Schulze, Lubatkin, Dino, & Buchholtz, 2001; Shapiro, 2005). Indeed, some critics have argued that the widespread teaching of agency theory, which suggests the opportunism is normative behavior among executives, is partially to blame for the many scandals observed in practice (Heath, 2009).

While information asymmetry has been utilized as a mechanism, construct, or boundary condition in the extant literature, it is most commonly discussed as an assumption, particularly within the confines of agency theory (Bergh et al., 2018). While this seems reasonable, an assumption connotes a static value on information asymmetry and limits its utility to theoretical development; the assumption basically limits the variance in information that exists across situations and our ability to better understand information asymmetry’s role in business and management phenomena. In other words, relaxing the assumption of information as highly asymmetric, equally asymmetric across parties, and/or inert may allow for theoretical advancement to be accomplished. Further, reconceptualizing information asymmetry as having various forms, including private information, different information, and hidden information (most commonly associated with classic agency theory), may lead to more valid theoretical models (Bergh et al., 2018).

Alternative Theoretical Perspectives

While the assumptions are necessary for the theory to be parsimonious and logically sound, they tend to be the primary source for criticism among scholars and can potentially explain the mixed empirical findings (Bosse & Phillips, 2016). Lan and Heracleous (2010) argue that the assumptions: (a) do not allow for a full understanding of corporate governance systems that involve collaborative behaviors, (b) fail to apply to contexts other than mature market-based economies, (c) do not fully explain the complexities of modern organizations, and (d) go against the commonly applied behavioral assumptions of many organizational theorists. Following these various criticisms, then, alternative theories and perspectives have emerged that warrant discussion. Namely, principal-principal agency, behavioral agency, and stewardship theories are considered very important developments. An overview of these different theories, along with principal-agent agency theory is provided in Table 1.

Table 1. Comparison of Agency Theory and Alternative Theoretical Perspectives

Principal-Agent Agency Theory

Principal-Principal Agency Theory

Behavioral Agency Theory

Stewardship Theory

Theoretical Foundations

Berle and Means (1932/2009); Jensen and Meckling (1976)

Walsh and Seward (1990); La Porta et al. (2000)

Wiseman and Gómez-Mejía (1998)

Donaldson (1990); Davis et al. (1997)

Theoretical Orientation

Alignment of interests of agents and principals

Goal incongruence between controlling and minority shareholders

Agent performance and motivation

Agent performance

Unit of Analysis

Agent–Principal

Principal–Principal

Agent–Principal

Agent–Stakeholders

Model of Man Behavior

Economic man

Economic man

Boundedly rational

Self-actualizing

Self-serving

Self-serving

Self-serving

Collective serving

Rational

Rational

Inequity averse

Agent identifying with firm goals

Individualistic

Individualistic

Individualistic

Collectivistic

Agent Motivation

Extrinsic

Both intrinsic and extrinsic

Both intrinsic and extrinsic

Intrinsic

Social Comparison

Other managers

Other shareholders

Other managers

Principal

Identification

Low-value commitment

Variable

Agent subject to psychological processes

High-value commitment

Power

Institutional

Concentrated ownership

Institutional and personal

Personal

Risk Orientation

Agent—risk averse

Variable across ownership groups

Agent—loss averse

Variable

Importance of risk-bearing

Principal—risk neutral

Principal—risk neutral

Key Mechanisms

Monitoring and incentive-based contracts

Reputation and government protections may limit expropriation of minority shareholders

Monitoring and incentive contracts (can also help motivation)

Autonomy

Principal-Principal Agency Theory

Principal-principal agency theory involves a deviation from traditional view of agency theory by recognizing and accounting for the fact that there may be different types or groups of principals involved in the firm; the different principals are expected to have different levels of authority and control, which will lead to conflict (Walsh & Seward, 1990). The application of the principal-principal perspective involves understanding the antecedents and consequences of this conflict and how organizations might mitigate the associated costs (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008).

Organizations with more concentrated ownership tend to have higher levels of principal-principal conflict and associated costs. While potentially problematic in all types of organizations, from large publicly traded companies to start-ups, perhaps the most common principal-principal situation is seen in family businesses, where a family-based group owns and controls a significant portion of the business and makes decisions accordingly. Basically, the amalgamation of owner and manager in the form of the family (or other controlling group) may result in negative outcomes due to the possibility of expropriation of firm resources, which refers to inappropriate transfer or use of firm resources by the majority or controlling shareholders relative to minority shareholders (non-family members) (Schulze et al., 2001; Shleifer & Vishny, 1997). Expropriation can take several different forms, varying from legal to illegal (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000). For example, expropriation may involve such actions as: (a) utilizing pyramid schemes and dual-class shares, (b) making purchasing decisions that support organizations owned or associated with the majority owners, (c) placing less-than-qualified associates (i.e., family members and friends) in key positions, and (d) making strategic decisions that advance the wealth or security of the controlling faction at the expense of firm performance, such as through over-diversification (Claessens, Djankov, & Lang, 2000; Faccio, Lang, & Young, 2001; Khanna & Rivkin, 2001; Young et al., 2008).

In sum, even though high ownership concentrations are arguably good for principal-agent costs (Fama & Jensen, 1983a, 1983b) and owner-managers (such as in family businesses) are well positioned and motivated to monitor and influence managers through goal congruence and trust (Habbershon & Williams, 1999; Lubatkin, Schulze, Ling, & Dino, 2005), principal-principal arguments would suggest there is a substantial chance for conflict and costs to occur (Claessens et al., 2000; Faccio et al., 2001). For instance, Young et al. (2008) argue that weak institutional support for formal governance mechanisms, commonly found in emerging economies, is associated with more principal-principal conflict, which may increase monitoring costs and undermine firm competitiveness. Therefore, the principal-principal perspective is substantively different from the principal-agent theory and may help explain theoretical inconsistencies and mixed empirical findings associated with traditional agency models.

Behavioral Agency Theory

Another notable refinement of agency theory is behavioral agency theory, which essentially assumes bounded rationality, accounts for human capital, and departs from the rational choice model of agency theory (Pepper & Gore, 2015; Wiseman & Gómez-Mejía, 1998). This theoretical perspective also focuses on maximizing the agent’s performance as a function of ability, motivation (both intrinsic and extrinsic), and opportunities (both in the internal and external environments), thus offering a more flexible framework. Major modifications of the classical agency perspective on performance and motivation, risk and uncertainty, time, and equitable pay, highlight the major differences and uses of this alternative theory. While these modifications are highlighted herein, Pepper and Gore (2015) provide a more complete discussion of behavioral agency theory and its applications.

While agency theory focuses on the alignment of goals between the agent and the principal, behavioral agency theory argues that the central goal of the principal is to optimize agent performance. In particular, behavioral agency argues for the importance of intrinsic motivation, suggesting that instead of viewing extrinsic and intrinsic motivation as separate or additive factors, they may trade-off each other to influence agent outcomes. However, there is an implicit assumption in much of the literature that intrinsic motivation is always advantageous to the firm although, in truth, intrinsic motivation (just like extrinsic motivation) has both advantages and disadvantages (Osterloh & Frey, 2000). The challenge here involves properly managing both intrinsic and extrinsic motivation mechanisms according to their relative advantages and disadvantages.

Another key modification of behavioral agency theory deals with risk and uncertainty. Contrary to agency theory, behavioral agency theory suggests that managers of firms are, first and foremost, loss averse, rather than risk averse. This follows from an extensive amount of evidence that demonstrates that executives do engage in risky behavior (e.g., Hayward & Hambrick, 1997). Loss aversion generally means that agents prefer options that avoid losses altogether over options that limit the size of the loss (Wiseman & Gómez-Mejía, 1998). This is important because it helps explain situations where the agent prefers riskier actions to avoid anticipated loss completely over less risky actions that minimize the loss (Thaler & Johnson, 1990).

More modern versions of behavioral agency theory also modify assumptions about time preferences, risk discounting, and inequity aversion. Such modifications represent efforts to provide more realistic behavioral assumptions than have been typically utilized by agency theorists (Pepper & Gore, 2015). As such, this perspective provides an alternative, if not improved, framework for better understanding the principal-agent relationship.

Stewardship Theory

Stewardship theory is also suggested as an alternative to classical agency theory and is founded on different behavioral assumptions. Stewardship theory essentially maintains that rather than being motivated by individual goals and self-interest, managers should be viewed as stewards of the firm, whose motives are generally aligned with the objectives of principals (Davis et al., 1997). Rooted in psychology and sociology, stewardship theory argues that organizational managers may be influenced by non-financial motivators (e.g., challenging work, authority, need for achievement) and may develop a close level of identification with the firm, as time and responsibility merge (Donaldson, 1990). In effect, and counter to agency theory, a manager is not, fundamentally, an opportunist. Rather, the manager desires to be a good steward and to do a good job on behalf of the principals.

Stewardship theory does not assume that interests of the principal and agent are always aligned, however. Rather, in situations where misalignment happens, the agent will place higher value on cooperation rather than defection. Stewardship theory explicitly assumes a strong relationship between the success of the firm and principals’ satisfaction, which is (according to the stewardship theory) a part of the steward’s utility function. Essentially, the main premise is that agents maximize their utility function, but a steward’s utility function is largely contingent on the principal’s satisfaction, rather than extrinsic mechanisms. As such, stewardship theory introduces psychological factors such as motivation, identification, and power, as well as context and situation, to the principal-agent relationship.

One of the important normative departures of stewardship theory from the agency theory is based on the argument that monitoring and tight controls can, in fact, limit the pro-organizational behavior of the steward. Counter to principal-agent agency theory arguments, stewardship theory suggests that performance can be maximized through deliberately extending agent autonomy and trust, because monitoring can reduce the residual loss of agent self-interest. However, it is important to note that these stewardship theory prescriptions only work when both the agent and the principal choose a stewardship relationship. If they both choose an agency relationship, then the situation of classical agency exists. Further, if one chooses the agency and the other chooses stewardship, then the stewardship party (which can be either the agent or the principal) will be betrayed in their expectations. Essentially, stewardship theorists argue that stewardship and agency are two possibilities in the agent-principal relationship and both perspectives fit relative to each other (Davis et al., 1997; Donaldson, 1990). However, often stewardship theory is viewed as directly opposing agency theory and many scholars have criticized it as unrealistic and naive (e.g., Albanese, Dacin, & Harris, 1997).

Moving Forward and Final Thoughts

Eisenhardt (1989) presented a review and summary of early work in agency theory, calling it an “important, yet controversial, theory” (p. 57); she also made several recommendations to advance the theory and the related field of study. Reflecting on the past few decades since Eisenhardt’s call, there have been many notable discoveries and developments in the field. Agency theory has served as a foundation for a massive amount of research that spans both decades and disciplines; it has also spawned multiple new theoretical perspectives that have been extremely useful for better understanding and predicting business and management phenomena. Given the complexity and extensiveness of the literature, it is somewhat daunting to consider where research can and should take the study of agency, although a few ideas are worth mentioning.

It is difficult to argue against the deductive logic of classical agency theory (Bosse & Phillips, 2016). At the same time, it is hard to ignore the empirical inconsistencies in the agency research. It seems logical, then, to suggest that the future of the agency theory lies not in the rejection of the theory outright, but rather in its continued adaptation and refinement. While such extensions and refinements are already underway, as is evidenced in the discussion of the three alternative theoretical perspectives, there appear to be additional areas for agency research and further theory building. First, and foremost, the issue of agency costs has not been given enough attention. Most of the extant research focuses on reducing the residual loss portion of the agency costs, with monitoring costs being assumed and bonding costs ignored. Indeed, bonding costs have been largely absent from both the empirical research and agency theorizing. This creates a paradigm where: (a) there is no a clear understanding of the actual structure of agency costs; and (b) there is an overreliance on the assumption that external monitoring does, in fact, reduce the residual loss portion of agency costs. Future efforts should explore these issues more fully. For example, Shi, Connelly, and Hoskisson (2017) found that, contrary to agency theory’s prescription for stronger external monitoring, external pressures can increase, rather than reduce, moral hazard.

Agency theory also generally assumes that all costs are ex post, meaning that they are incurred after the agency contract is formed. However, this assumption is problematic because there are clearly ex ante costs of the agency contract. Based on Jensen and Meckling’s (1976) definition of the firm as a “nexus of contracts,” an agency relationship is essentially a human capital contract. Agency theory assumes that the ex ante costs of agency relations are nonexistent in the presence of the contract. Specifically, once the contract is negotiated, human labor market imperfections and their costs are assumed away in the terms of the contract. While this may be true in non-human, property-based contracts, this is not likely to be the case in human resource contracts. Future efforts should consider the costs of contracting, perhaps following signaling theory, which discusses how costs of signals can be incurred both before and after the signal is sent (e.g., Payne, Moore, Bell, & Zachary, 2013).

Another potential venue for agency research lies in further exploring the importance and effects of individual characteristics and behaviors of the agent and the principal. As Shapiro (2005, p. 266) notes “the assumption that complex organizational structures and networks can be reduced to dyads of individuals” is too simplistic and is driven largely by the requirements of mathematical models. Essentially, empirical modeling and over-reliance on extensive assumptions has led to significant limitations for the theory; progress in terms of explaining human behavior, in particular, has been stifled because individuals are not fully recognized as the complex and emotionally driven entities that they are. In other words, humans are not only driven by rational thought but also by a number of other factors including individual dispositions and personalities (e.g., Petrenko, Aime, Ridge, & Hill, 2016). Such influences should be more explicitly considered, particularly when also considering varying situations and contexts (e.g., Finkelstein, Hambrick, & Cannella, 2009). Indeed, it is worth considering how principal-agent and principal-principal relationships may differ when compare across geographic contexts and cultures, since the majority of governance research has utilized insights and samples from the United States and Europe (Young et al., 2008). Basically, agency theory would benefit from becoming not only more behavioral but also by better recognizing the social and contextual aspects of the principal-agent relationship. Shapiro (2005) provides an overview of agency theory from a sociological perspective and offers several promising venues for future research along this vein.

In conclusion, while agency theory has produced mixed results, it has also created a wealth of research that has significantly advanced a collective understanding of the principal-agent relationship. Most relevant to business and management scholarship, agency theory has served as a solid, although somewhat rigid, foundation for examining the issues of corporate governance and control. Building on this foundation provides ample opportunities for extending the theory to make it more flexible, realistic, and applicable across various situations and contexts. This work is already underway, but there is still much more to be done.

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