Kaitlyn CaldwellACC 8023-02Dr. Brad LangDecember 4, 2018Final Exam Paper With many problems surfacing in the business world, both past and present, we find many circulate around the agency theory. The agency theory has been around for many years and over the years, there have been many definitions attached to its name. Some find the most relevant definitions to be centered around the relationship between a principal and agent. The principal-agent relationship can be between the boss and employee, management and stakeholders, or management and executive level management. Due to the importance of trust placed between these relationships, sometimes lines can be crossed due to the self-serving nature that is within us. Some areas within the business world that tempt people to break this trust in order to better themselves are: earnings management and compensation and incentive plans. While both of these areas have become common practice for many companies, there are still cases where we see the line crossed into fraudulent territory. Some say implementing better business ethics into the workforce will mitigate this problem. Throughout this paper, we will discuss agency theory, its relationship to earnings management, and its relationship to compensation and incentive plans. We will then move on to discuss business ethics in detail and how business ethics are generally applied in today’s environment. We will then tie business ethics into the agency theory and discuss how they affect one another.
Agency theory is just that: a theory. This theory attempts to solve the problems that occur within the principal-agent relationship. A principal is an individual who hires someone else, the agent, to act on his or her behalf. While this relationship can be efficient in some scenarios, problems can arise because the goals between the principal and agent may not always align. The goals of both tend to be misaligned due to the self-serving nature of the human mind. This means that the principal or agent will serve their own interests and welfare before those of others, often resulting in the goal incongruence that was previously mentioned. When an agent is allowed to act on behalf of a principal, the agent is incentivized to maximize his or her individual utility (Schoorman & Donaldson 1997). While agency theory is continuously viewed upon in a negative sense, we must give it praise because it has helped us in research. Kathleen M. Eisenhardt introduces the contributions of agency theory in her paper. Relating specifically to organizational thinking, she says the agency theory makes two specific contributions (Eisenhardt 64). Eisenhardt begins by talking about the treatment of information and how agency theory treats information as a commodity; it has a cost and can be purchased (64). This implies that businesses can purchase various commodities to control their principal or agent’s opportunistic behavior. The next contribution that Eisenhardt mentions is that agency theory gives us risk implications (65). Agency theory extends organizational thinking by pushing the ramifications of outcome uncertainty to their implications for creating risk and this push implies that outcome uncertainty coupled with differences in willingness to accept risk should influence contracts between principal and agent (Eisenhardt 65). Both of these contributions are essentially centered around the concept of a contract between the principal and agent. One caveat on Eisenhardt’s research is that her contributions seem to imply complete mitigation of the principal-agent dilemma completely. While we all know that this is impossible, it is nice to see that agency theory can be thought of in a positive light.