Economics of Organization Chapter 4: Agency Theory - PowerPoint PPT Presentation

Loading...

PPT – Economics of Organization Chapter 4: Agency Theory PowerPoint presentation | free to download - id: 78d269-MjY0O



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Economics of Organization Chapter 4: Agency Theory

Description:

Economics of Organization Chapter 4: Agency Theory Joe Mahoney University of Illinois at Urbana-Champaign – PowerPoint PPT presentation

Number of Views:21
Avg rating:3.0/5.0
Slides: 21
Provided by: JoeM118
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Economics of Organization Chapter 4: Agency Theory


1
Economics of Organization Chapter 4 Agency
Theory
  • Joe Mahoney
  • University of Illinois at Urbana-Champaign

2
Agency Theory
  • Berle and Means (1932)
    The Modern Corporation
  • Pratt and Zeckhauser (1985)
    Principals and Agents
  • Arrow (1985) The Economics of Agency
  • Levinthal (1988)
    Agency Models of Organizations
  • Jensen and Meckling (1976)
  • Theory of the Firm Managerial Behavior, Agency
    Costs, and Capital Structure

3
Berle and Means (1932) The Modern
Corporation
  • Argues that the separation of ownership from
    control produces a condition where the interests
    of owner(s) and managers often diverge and that
    discretionary power by managers exists.
  • They ask Have we any justification for
    assuming that those in control of the modern
    corporation will also choose to operate it in the
    interest of owners? (1932 121)

4
Berle and Means (1932) The Modern
Corporation
  • In their empirical study they find that 88 of the
    200 largest American non-financial corporations
    were management controlled in 1929 because no
    individual, family, corporation, or group of
    business associates owned more than 20 percent
    share of all outstanding stock, and because
    evidence of control by a smaller ownership group
    was lacking.
  • They judged only 22 to be privately
    owned or controlled by a group of stockholders
    with a majority interest.

5
Berle and Means (1932) The Modern
Corporation
  • They conclude that the State seeks in some
    respects to regulate the corporation, while the
    corporation, steadily becoming more powerful,
    makes every effort to avoid (or shape) such
    regulation. Where its interests are concerned,
    the modern corporation even attempts to dominate
    the State. The future may see the economic
    organization, typified by the corporation, not
    only on an equal plane with the State, but
    possibly even superseding the State as the
    dominant form of social organization. The law of
    the corporation, accordingly, might well be
    considered as a potential constitutional law for
    the new economic State, while business practice
    is increasingly assuming the aspect of economic
    statesmanship.

6
Pratt and Zeckhauser (1985) Principals and
Agents
  • Given information asymmetries --- agents
    typically know more about their tasks than their
    principals do --- we cannot expect any business
    enterprise or business institution to function as
    well as it would if all information were
    costlessly shared or if the economic incentives
    of principals and agents could be costlessly
    aligned.
  • This shortfall is sometimes called the
    agency loss or agency costs.

7
Pratt and Zeckhauser (1985) Principals and
Agents
  • In economic language, since the first-best
    outcome could only be achieved in the unrealistic
    world of costless information flow, our goal must
    be to do the best we can, to achieve what is
    sometimes called the second-best solution.
  • The building blocks of agency theory are
    information and economic incentives.

8
Pratt and Zeckhauser (1985) Principals and
Agents
  • Information
  • At one extreme we have the perfect-market
    transaction, with standardized products and all
    information fully shared.
  • At the other end of the continuum are situations
    in which the agent has full discretion and is not
    observed at all by the principal.

9
Pratt and Zeckhauser (1985) Principals and
Agents
  • Agency loss is more severe when the economic
    interests or economic values of the principal and
    agent diverge substantially, and information
    monitoring is costly
  • The economic benefits of any reduction in agency
    loss will be shared by principal and agent in
    most market situations.

10
Pratt and Zeckhauser (1985) Principals and
Agents
  • The principal and agent have a common economic
    interest in defining a monitoring-and-incentive
    structure that produces economic outcomes as
    close as possible to the economic outcome that
    would be produced if information monitoring were
    costless.
  • Human environments can change quickly and there
    is no assurance that the institutions we
    currently observe are best.

11
Arrow (1985) The Economics of Agency
  • Finds it useful to distinguish two types of
    agency problems
  • Hidden action models (moral hazard)
  • Moral hazard and observability (Holmstrom,
    1979)
  • Hidden information models (adverse
    selection)
  • The market for lemons
    (Akerlof, 1970)

12
Arrow (1985) The Economics of Agency
  • Arrow observes that in some cases where the
    principal-agent theory seems clearly applicable,
    real-world practice is very different from the
    model. In many respects, the physician-patient
    relation exemplifies the principal-agent
    relationship almost perfectly.
  • The principal (the patient) is certainly unable
    to monitor the efforts of the agent (the
    physician).
  • The relation between effort and outcome is
    random, but presumably there is some connection.
  • Yet in practice, the physicians fee schedule is
    in no way related to outcome. In general,
    compensation of professionals shows only a few
    traces of the complex fee schedules implied by
    agency theory.

13
Arrow (1985) The Economics of Agency
  • Why is the divergence between agency theory and
    practice so stark?
  • One basic problem is the cost of specifying
    complex relations.
  • Second, superiors judge executives on criteria
    that could not have been stated in advance.
    Outcomes and even supplementary objective
    measures do not exhaust the information available
    on which to base rewards.
  • Professional responsibility is clearly enforced
    in good measure by a system of ethics,
    internalized during the education process and
    enforced in some measure by formal punishments
    and more broadly by reputations.

14
Levinthal (1988) Agency Models of
Organizations
  • Provides the insightful perspective that the
    agency paradigm can be viewed as the neoclassical
    response to questions raised many years earlier
    by March and Simon (1958) and Cyert and March
    (1963) regarding the behavior of an organization
    of self-interested agents with conflicting goals
    in a world of incomplete information.
  • Judges, however, that the focus on the incentive
    problem in the organizational economics and
    strategic management literatures is excessive.
    The inability of top management to coordinate
    goes well beyond the problem of industriousness.
    The strategic management literature should also
    allocate time and attention to offering superior
    heuristics for management to achieve coordination.

15
Levinthal (1988) Agency Models of
Organizations
  • Role of Time
  • Levinthal (1988) notes that the repetition of an
    agency relationship over time tends to improve
    its efficiency.
  • When the agency relationship repeats itself over
    time, the effects of uncertainty tend to be
    reduced and dysfunctional behavior is more
    accurately revealed, thus alleviating the problem
    of moral hazard.

16
Levinthal (1988) Agency Models of
Organizations
  • Multi-agent models and tournament contracts
  • Levinthal maintains that the risk imposed on an
    agent can be reduced by basing by basing
    individual performance relative to that of other
    agents, who face similar states of nature. For
    example, in tournaments, the reward is a
    function of the rank order of performance
    relative to other agents.

17
Jensen and Meckling (1976) Theory of the Firm
Managerial Behavior, Agency Costs, and Capital
Structure
  • Jensen and Meckling (1976) integrate elements
    from agency, the theory of property rights and
    the theory of finance to develop a theory of the
    ownership structure of the firm.
  • Agency costs are defined as
  • The monitoring costs by the principal
  • The economic bonding costs by the agent
  • The residual economic loss.

18
Jensen and Meckling (1976) Theory of the Firm
Managerial Behavior, Agency Costs, and Capital
Structure
  • Jensen and Meckling (1976) argue that agency
    costs (I.e., monitoring costs, economic bonding
    costs, and the residual loss) are an unavoidable
    result of the agency relationship.
  • Jensen and Meckling (1976) argue that contractual
    relations are the essence of the firm, not only
    with employees (Alchian and Demsetz, 1972), but
    also with suppliers, customers, creditors, and so
    on.

19
Jensen and Meckling (1976) Theory of the Firm
Managerial Behavior, Agency Costs, and Capital
Structure
  • Jensen and Meckling (1976) argue that most
    organizations serve as a nexus for a set of
    contracting relationships among individuals.
  • Jensen and Meckling (1976) emphasize that since
    decision makers ultimately bear the agency costs,
    these decision makers have the economic incentive
    to minimize agency costs.

20
Jensen and Meckling (1976) Theory of the Firm
Managerial Behavior, Agency Costs, and Capital
Structure
  • Jensen and Meckling (1976) argue that agency
    costs (I.e., monitoring costs, economic bonding
    costs, and the residual loss) are an unavoidable
    result of the agency relationship.
  • Jensen and Meckling (1976) conclude that the
    level of agency cost depends, among other things,
    on statutory and common law, and human creativity
    in devising better contracts. Both the law and
    the sophistication of contracts relevant to the
    modern corporation are the products of an
    historical process in which there were strong
    economic incentives for individuals to minimize
    agency costs.
About PowerShow.com