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Theoretical Perspective Of Main Agent Theory

According to Random House Dictionary, theory is "a coherent band of standard propositions used as ideas of justification for a category of phenomena". Within the formal meanings of the term, theory gets the following three meanings (Frederickson and Smith, 2003):

Theory in the natural sciences is the strenuous tests of predictive theorems or assumptions using observable and similar data. The examined and verified hypotheses constitute the foundation of theories. And theories derived from this process usually serve as an extremely reliable direction for tendencies.

Theories in the cultural sciences, including open public administration, implies the sequence of factual material (history, events, conditions, stories, measures of opinion, observations) offered in definitions, ideas, and metaphors to market understanding. The rigorous and the intuitive observation of sociable behavior, patterns of communication, and culture is the foundation to this theory.

The last meaning of theory in public supervision is the theories of what should to be. These theories create the bridge between open public administration, political technology, and viewpoint. The theorists aim at discovering theories that account for, explain, or explain observable trends in behavior also to measure the normative cues of such patterns.

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

Hence, an important mission of scholars and teachers in the areas of management, health, education, and interpersonal work is, on the main one hand to execute researches that add knowledge to a medical discipline, also to apply that knowledge to the practice of management as a profession, on the other (Simon, 1967). To get this done well, we have to design our research such that it provides an seductive understanding of the sensible problems facing the occupation. Equally important, we need to appreciate and improve our skills in growing good theory so that research conducted about these problems will boost the knowledge that is relevant to both self-discipline and the vocation (Truck DE Ven, 1989).

Therefore, this newspaper aims at discussing what is theoretical from the perspective of principal-agent theory. It really is consisted of four areas: 1) What's Principal-Agent Theory; 2) What's the theoretical contribution of Principal-Agent Theory; 3) Constraints of Principal-Agent Theory; 4) Finish.

Principal-Agent Theory

One day Deng Xiaoping decided to take his grandson to go to 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?" advised Deng. No quicker possessed Mao done so than the young man happily chirped, "Oh thank you, Granduncle. " "The thing is, " said Deng, "what incentives can achieve. " (Capitalism, 1984)

According to Arrow (1971) and Wilson (1968), during the 1960s and early 1970s, economists looked into risk writing among individuals or categories. The risk-sharing problem, described in this books, comes up when collaborating celebrations have different standpoints toward risk. Principal-Agent theory widened the risk-sharing books to include what is called firm problem. And organization problem occurs when cooperating people have different goals, information, and division of labor (Jensen & Meckling, 1976). Specifically, principal-agent theory concentrates on the ubiquitous agency-relationship, "in which one party (the main) delegates work to another (the agent), who functions that work in behalf of the principal" (Eisenhardt, 1989). And principal-agent theory seeks to portray this romantic relationship using the metaphor of the agreement (Jensen & Meckling, 1976).

As a consequence, the central problem explored by primary agent theorists is how to stimulate the employee or service provider (agent) to behave in the best interests of the principal (the employer) when the staff or contractor has an informational benefit over the principal and has different hobbies from the principal. From the firm point of view, "most organizations are simply legal fictions which serve as a nexus for a couple of contracting relationships among individuals" (Jensen and Meckling, 1976). The essential premise of the idea is the fact that "if both get-togethers to the relationship are energy maximisers, you can find justification to believe that the agent will not always react in the needs of the main" (Jensen and Meckling, 1976).

In deciding the most efficient contract, principal-agent theory introduces certain hypotheses about people, organizations and information. It assumes that realtors and principals will action in their self-interest to increase their own welfare. Agents possess more info than their principals have got. Because of this, it identifies two impediments to effective contractual performance: moral hazard and adverse selection. Moral threat refers to that the agent doesn't put agreed-upon work to the jobs. That's, the agent is shirking. Adverse selection identifies "the misrepresentation of potential by the agent" (Eisenhardt, 1989). The agent may declare to have certain skills, experiences, or capacities when he or she is appointed. Adverse selection develops because the principal cannot completely check these skills, experience, or features either at the time of recruitment or while the agent is working (Eisenhardt, 1989).

Two types of problems are especially relevant. Is the "agency problem" which arises from the conflicting goals of the main and the agent and from the difficulty/charge involved in verifying the agent's habit (Eisenhardt, 1989). The second is the situation of "risk-sharing" which comes from the different behaviour toward risk for the principal and the agent. The different risk preferences between the principals and realtors are likely to lead to different activities. Therefore, the theory concentrates on the contract between the principal 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 conflict prevails between principals and agencies and that agencies have more information than their principals, which results in an information asymmetry between them (Waterman and Meier, 1998).

Goal Issue. "In the marketplace, principals and agents plainly have different goals and/or preferences" (Waterman and Meier, 1998). Commonly, agencies want to make as much money as is feasible, however principals want to pay as little as easy for services. Exactly like in the general public sector. The federal government wants to produce as more general public goods as is feasible, while the builder agents be prepared to reduce the cost whenever you can. Therefore, in a deal romantic relationship, maximum principals' interest couldn't undoubtedly contribute to the maximum of agents' interests. It could even reversely worsen realtors' advantages, such as less payment or profit. As a consequence, how to encourage agents to accomplish principals' goals at the very least cost has become a great challenge.

Information Asymmetry. "Even as we already have known, the info asymmetry is a critical assumption of the principal-agent model. The info asymmetry is merely the claim that agents possess more information than their principals own. " (Waterman and Meier, 1998) When the syndication of information between principal and agent is asymmetric, the "classic" principal-agent problem occurs. The problem brought up here's how to avoid information asymmetry so that principals know to what extent the real estate agents have achieved the principals' goals, what agencies are doing, and what exactly are not done. With these information, principals could better keep an eye on the contract relation and working process to improve organizational performance.

"In addition to the assumption that incomplete goal discord is inherent in 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.

Table 1 Principal-Agent Theory Overview

Key Idea


Principal-agent romantic relationships should reflect efficient firm of information and risk-bearing costs

Unit of Analysis

Contract between main and agent

Human Assumptions


Bounded rationality

Risk aversion

Organizational Assumptions

Partial goal turmoil among participants

Efficiency as the effectiveness criterion

Information asymmetry between main and agent

Information Assumptions

Information as a purchasable commodity

Contracting Problems

Agency (moral threat and adverse selection)

Risk sharing

Problem Domain


Relationships where the primary and agent have partially differing goals and risk preferences (e. g. , payment, regulation, leadership, impression management, whistle-blowing, vertical integration, copy pricing)

Source: Eisenhardt, Kathleen M. (1989). Agency Theory: An Analysis and Review. The Academy of Management Review, Vol. 14, No. 1, p. 59

Theoretical Contribution of Principal-Agent Theory

Principal-Agent theory has been contributing too much to organization theory and incentive theory. "Principal-Agent theory has been the basis for an intensive set of studies relating bureaucracy to elected officials. It also has been extended to presidents' decisions to utilize force and also to the Supreme Courtroom and its relationship to lower courts. " (Waterman and Meier, 1998) Before speaking about the theoretical contribution of principal-agent theory, Let me talk about exactly what is a good theory.

Above all, a good theory is the theory appropriately used. "All ideas are false. They can be, after all, just words and symbols on bits of paper, about the truth they purport to spell it out; they aren't that reality. So they simplify it. This means we should choose our ideas corresponding to how useful these are, not how true they are really. " (Mintzberg, 2005) Definitely, principal-agent theory is not omnipotent to explain or solve all problems within an organization. It really is true only when it is properly used.

Furthermore, a good theory is sensible precisely. "A theory to be useful, should accurately identify or depict a genuine world event or trend. " (Frederickson and Smith, 2003) The first section has showed 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 at first surprises-that is, changes perceptions. " (Mintzberg, 2005) From this point of view, principal-Agent theory might not significantly change perceptions, but it surely earns some new considering organizations and incentives.

Firstly, "Principal-Agent theory reestablishes the value of bonuses and self-interest in organizational thinking. It reminds us that a lot 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 boost their own resources. Agents would not voluntarily produce dreams of principal which is difficult or expensive for the principal to investigate the actual agent is really doing. Hence, it is significant for principals to provide incentives to real estate agents which lead for an position of goals between main and agent, to be able to make sure that the realtors work for principals' goals. That is to maximize principals' interests rather than impair principals' efficiency through agencies' over ownership of information.

Secondly, Principal-Agent theory also makes important efforts to organizational thinking, the most important which is the treating information. (Eisenhardt, 1989). In principal-agent theory, information is recognized as items: it has a cost, and it can be exchanged and purchased. "The implication is the fact that organizations can spend money on information systems to be able to regulate agent opportunism", an illustration which is the executive reimbursement. And one of the critical indicators such compensation requires is information systems. It is assumed that "richer information systems control managerial opportunism and, therefore, lead to less performance-contingent pay". Board of directors is recognized as a definite relevant information system to monitor executive behaviors. "When planks provide richer information, compensation is less inclined to be based on solid performance. Also, when boards provide richer information, top professionals will engage in habits that are consistent with stockholders interest. " (Eisenhardt, 1989) Besides, to break providers' superiority position on information is of great relevance to keep balance between principals and agencies and improve agents' performance.

Moreover, profit writing has been trusted as an attempt to give employees more opportunities to involve into and to get pleasurable sentiment from the business also to make employees feel these are area of the group; to increase employees' sense of commitment to group; to increase sense of co-operation between management and subordinates; and also to ensure employees benefit from organization success. In the general public sector, administrators should frequently require into policy-making process. Participatory management could be an efficient approach to get an alignment of goals of the management and subordinates also to motive employees' performance awareness.

In addition, Principal-Agent theory could be utilized to elucidate hierarchical control of organizations as well (Moe, 1984). Difficulty in monitoring the activities of subordinates/brokers, asymmetric information superior status of subordinates/providers, or transactions costs in supervising and verifying the actions of subordinates/real estate agents all can give agents opportunities to escape from principals' goals by making the most of agents' interests. "Typically, principals find methods to ameliorate these problems, for example, by counting on signals that warn them when realtors step outside certain bounds. " (Song, Segal, and Cameron, 1976)

Limitations of Principal-Agent Theory

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

Principal-Agent Theory just displays a incomplete aspect of the real world, although it is valid, looked after ignores a great amount of organizational complexity. Additional perspectives could contribute to attain the greater important complexity (Eisenhardt, 1989). Corresponding to Ogden (1993), "the highly simplified style of organizational conflict and the contrasting complexity of the mathematics required 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 difficult range of contexts. Principal-agent theory studies the relationship between the principal and the agent defined by contract, resting on a basis in economics. Under this theory, romantic relationship problems are described from a contractual point of view; and solutions derives from the change of contract. However, noneconomic factors should be emphasized as well, such as ethnical, social, mental, and political. And some scholars have already argued to check out important non-contractual areas of principal-agent relationship. So, to review principal-agent romantic relationship from non-contractual perspectives is demanded and valuable.


Starting from an advantages to what is the principal-agent theory and the importance of the theory in public administration, we conclude that the principal-agent theory has contributed too much to the development of company theory and incentive theory. Although theoretical significant, principal-agent theory still has its limitations, such as simplified model and ignorance of non-economic factors, which leaves quite a distance for future development.

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

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