Theoretical FROM YOUR Perspective Of Principal Agent Theory Management Essay

Theory in the natural sciences is the demanding tests of predictive theorems or assumptions using observable and comparable data. The examined and confirmed hypotheses constitute the building blocks of theories. And theories produced from this process usually provide as an extremely reliable path for action.

Theories in the communal sciences, including public administration, suggests the series of factual materials (history, events, conditions, stories, methods of thoughts and opinions, observations) shown in definitions, principles, and metaphors to market understanding. The thorough and the intuitive observation of public behavior, habits of communication, and culture is the foundation to the theory.

The last interpretation of theory in public areas supervision is the theories of what should to be. These ideas create the bridge between open public administration, political knowledge, and viewpoint. The theorists aim at discovering theories that take into account, explain, or identify observable movements in behavior also to measure the normative cues of such habit.

"It is often true that general public administration theorists use a mix of the next and third explanation of theory. " And there is absolutely no hesitation that "theory is the bedrock of knowledge of public administration" (Frederickson and Smith, 2003). If manuscripts contain no theory, their value is suspect (Whetten, 2000).

Hence, an important objective of scholars and educators in the regions of management, health, education, and public work is, on the one hand to carry out researches that add knowledge to a technological discipline, also to apply that knowledge to the practice of management as a profession, on the other (Simon, 1967). To do this well, we have to design our research such that it provides an intimate understanding of the functional problems facing the job. Equally important, we need to appreciate and improve our skills in producing good theory so that research conducted about these problems will boost the knowledge that is pertinent to both self-control and the profession (Truck DE Ven, 1989).

Therefore, this newspaper aims at speaking about what's theoretical from the point of view of principal-agent theory. It is consisted of four portions: 1) What is Principal-Agent Theory; 2) What's the theoretical contribution of Principal-Agent Theory; 3) Limitations of Principal-Agent Theory; 4) Summary.

Principal-Agent Theory

One day Deng Xiaoping made a decision to take his grandson to visit Mao. "Call me granduncle, " Mao offered warmly. "Oh, I certainly couldn't do that, Chairman Mao, " the awe-struck child replied. "The trend is to give him an apple?" suggested Deng. No quicker acquired Mao done so than the young man gladly chirped, "Oh many thanks, Granduncle. " "The simple truth is, " said Deng, "what bonuses can achieve. " (Capitalism, 1984)

According to Arrow (1971) and Wilson (1968), through the 1960s and early 1970s, economists investigated risk writing among individuals or groupings. The risk-sharing problem, defined in this books, comes up when collaborating parties have different standpoints toward risk. Principal-Agent theory widened the risk-sharing books to include what is called firm problem. And company problem occurs when cooperating parties have different goals, information, and division of labor (Jensen & Meckling, 1976). Specifically, principal-agent theory concentrates on "the ubiquitous agency-relationship, where one get together (the principal) delegates work to another (the agent), who performs that work in behalf of the principal" (Eisenhardt, 1989). And principal-agent theory seeks to portray this romantic relationship using the metaphor of an agreement (Jensen & Meckling, 1976).

As a outcome, the central issue explored by main agent theorists is how to energize the staff or builder (agent) to react in the needs of the principal (the workplace) when the staff or contractor has an informational benefits over the principal and has different interests from the principal. From the company perspective, "most organizations are simply legal fictions which provide as a nexus for a couple of contracting relationships among individuals" (Jensen and Meckling, 1976). The basic premise of the theory is the fact that "if both functions to the partnership are energy maximisers, there exists justification to believe that the agent won't always action in the needs of the principal" (Jensen and Meckling, 1976).

In identifying the most efficient deal, principal-agent theory brings up certain hypotheses about people, organizations and information. It assumes that agencies and principals will action in their self-interest to maximize their own welfare. Realtors possess more info than their principals maintain. Because of this, it identifies two impediments to effective contractual performance: moral hazard and adverse selection. Moral threat identifies that the agent doesn't put agreed-upon attempts to the duties. That is, the agent is shirking. Adverse selection refers to "the misrepresentation of potential by the agent" (Eisenhardt, 1989). The agent may lay claim to have certain skills, encounters, or capacities when he or she is chosen. Adverse selection comes up because the main cannot completely validate these skills, activities, or features either during recruitment or as the agent is working (Eisenhardt, 1989).

Two types of problems are especially relevant. You are the "agency problem" which comes from the conflicting goals of the principal and the agent and from the difficulty/expenditure involved with verifying the agent's habit (Eisenhardt, 1989). The second reason is "the problem of risk-sharing" which arises from the different attitudes toward risk on the part of the main and the agent. The different risk preferences between your principals and providers are likely to lead to different actions. Therefore, the idea concentrates on the contract between your primary and the agent and "the ways in which the contract can be produced most efficient from the idea of view of the main" (V. Nilakant, 1994).

Besides, the idea makes two assumptions: that goal turmoil exists between principals and agencies and that brokers have more information than their principals, which results within an information asymmetry between them (Waterman and Meier, 1998).

Goal Discord. "Available on the market, principals and real estate agents obviously have different goals and/or preferences" (Waterman and Meier, 1998). Commonly, real estate agents want to make just as much money as possible, however principals want to pay as little as possible for services. Exactly like in the general public sector. The government wants to produce as more open public goods as it can be, while the company agents expect to reduce the cost as much as possible. Therefore, in a deal romance, maximum principals' interest couldn't inevitably contribute to the utmost of real estate agents' interests. It might even reversely get worse real estate agents' advantages, such as less settlement or profit. As a result, how to encourage agents to accomplish principals' goals at the very least cost has become a great concern.

Information Asymmetry. "Once we already have mentioned, the information asymmetry is a critical assumption of the principal-agent model. The information asymmetry is simply the claim that agents possess more info than their principals hold. " (Waterman and Meier, 1998) If the syndication of information between principal and agent is asymmetric, the "classic" principal-agent problem arises. The problem raised here is how to avoid information asymmetry so that principals know from what extent the brokers have achieved the principals' goals, what realtors are doing, and what exactly are not done. With these information, principals could better keep an eye on the agreement relation and working process to boost organizational performance.

"As well as the assumption that partial goal discord is inherent in virtually any principal-agent romantic relationship, principal-agent theory also presumes that information about the agent is a commodity that may be purchased. " (V. Nilakant, 1994) Table 1 presents a synopsis of principal-agent theory, including key idea, device of analysis, individuals assumptions, organizational assumptions, information assumptions, and contracting problems.

Theoretical Contribution of Principal-Agent Theory

Principal-Agent theory has been contributing a lot to firm theory and incentive theory. "Principal-Agent theory has been the basis for an extensive set of studies relating bureaucracy to elected officers. In addition, it has been extended to presidents' decisions to use force and also to the Supreme Court docket and its romantic relationship to lower courts. " (Waterman and Meier, 1998) Before talking about the theoretical contribution of principal-agent theory, I'd like to talk about what is a good theory.

Above all, a good theory is the idea correctly used. "All theories are wrong. " "They can be, in the end, just words and icons on pieces of paper, about the truth they purport to describe"; they aren't that fact. So they simplify it. "This implies we must choose our ideas relating to how useful they may be, not how true they can be. " (Mintzberg, 2005) Definitely, principal-agent theory is not omnipotent to make clear or solve all problems within an organization. It really is true only once it is correctly used.

Furthermore, a good theory is sensible accurately. "A theory to be useful, should effectively express or depict a genuine world event or sensation. " (Frederickson and Smith, 2003) The first section has proven that principal-agent theory will fit this need. Scholars specialized in this theory have explicitly referred to what principal-agent is and what it could explain in real life.

Finally, a good theory is insightful and predictive. "Theory is insightful when it surprises, when it allows us to see profoundly, imaginatively, unconventionally into phenomena we thought we understoodtheory is useless unless it primarily surprises-that is, changes perceptions. " (Mintzberg, 2005) From this point of view, principal-Agent theory may well not dramatically change perceptions, but it really earns some new thinking about organizations and incentives.

Firstly, "Principal-Agent theory reestablishes the importance of bonuses and self-interest in organizational thinking. It reminds us that much of organizational life, whether we like it or not, is based on self-interest. " (Eisenhardt, 1989) Both principal and agent are usually assumed to be attempting to improve their own resources. Agents wouldn't normally voluntarily produce wishes of principal and it is usually hard or expensive for the main to investigate the actual agent is really doing. Hence, it is significant for principals to provide incentives to agents which lead to a positioning of goals between primary and agent, in order to make sure that the realtors work for principals' aims. That is to maximize principals' interests somewhat than impair principals' efficiency through real estate agents' over ownership of information.

Secondly, Principal-Agent theory also makes important efforts to organizational thinking, "the main which is the treating information". (Eisenhardt, 1989). In principal-agent theory, information is considered as items: it has a cost, and it could be exchanged and purchased. "The implication is the fact that organizations can spend money on information systems in order to control agent opportunism", an illustration of which is the professional compensation. And one of the critical indicators such settlement requires is information systems. The assumption is that "richer information systems control managerial opportunism and, therefore, lead to less performance-contingent pay". Table of directors is recognized as a definite relevant information system to monitor executive behaviours. "When planks provide richer information, reimbursement is less likely to be based on firm performance. Also, when planks provide richer information, top executives are more likely to engage in conducts that are constant with stockholders interest. " (Eisenhardt, 1989) Besides, to break providers' superiority position on information is of great relevance to keep balance between principals and providers also to improve brokers' performance.

Moreover, profit sharing has been trusted as an effort to provide employees more opportunities to involve into and to get pleasurable sentiment from the business and make employees feel they are simply part of the company; to increase employees' sense of determination to corporation; to increase sense of co-operation between management and subordinates; also to ensure employees reap the benefits of organization profitability. In the general public sector, administrators should frequently involve into policy-making process. Participatory management could be a competent method of get an positioning of goals of the management and subordinates also to motive employees' performance awareness.

In addition, Principal-Agent theory could be used to elucidate hierarchical control of organizations as well (Moe, 1984). Difficulty in monitoring the activities of subordinates/agents, asymmetric information superior status of subordinates/real estate agents, or deals costs in supervising and verifying the actions of subordinates/agents all can give agents opportunities to flee from principals' goals by maximizing agents' pursuits. "Typically, principals find means to ameliorate these problems, for example, by relying on signals that warn them when brokers step outside certain bounds. " (Music, Segal, and Cameron, 1976)

Limitations of Principal-Agent Theory

Principal-Agent theory, which characterizes human relationships that develop and evolve, is supposed to be always a dynamic, rather than static theory (Waterman and Meier, 1998). It provides insightful and predictive theoretical contribution to firm and motivation theory development. Principal-agent theory "provides a unique, practical, and empirically testable perspective on problems of cooperative work (Eisenhardt, 1989)". Besides its theoretical contribution, however, principal-agent theory needs further improvement as the next:

Principal-Agent Theory only displays a partial aspect of real life, though it is valid, and it also ignores a great amount of organizational difficulty. Additional perspectives could donate to attain the greater important intricacy (Eisenhardt, 1989). Regarding to Ogden (1993), "the highly simplified model of organizational discord and the contrasting complexity of the mathematics necessary to provide answers to the firm problem have been frequently cited as restrictions to principal-agent theory".

In addition, principal-agent theory could be developed to a richer and more complicated selection of contexts. Principal-agent theory studies the relationship between the main and the agent which is defined by contract, resting over a basis in economics. Under this theory, relationship problems are discussed from a contractual point of view; and solutions derives from the change of deal. However, noneconomic factors should be emphasized as well, such as cultural, social, mental health, and political. Plus some scholars have previously argued to look at important non-contractual areas of principal-agent relationship. So, to review principal-agent romance from non-contractual perspectives is demanded and valuable.


Starting from an launch to what is the principal-agent theory and the value of the idea in public supervision, we conclude that the principal-agent theory has contributed too much to the introduction of business theory and motivation theory. Although theoretical significant, principal-agent theory still has its limits, such as simplified model and ignorance of non-economic factors, which leaves a long way for future development.

Nevertheless, this term paper merely offers a brief review and summation of principal-agent theory and its own theoretical contributions. It really is far from a comprehensive and deep analysis on principal-agent problems and alternatives. Much more works are needed to elaborately review this theory.

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