Exploring the Effects of Agency Theory on Ownership Structures and Firm Performance

Posted: 23 Mar 2021

See all articles by Radhika Nidumolu

Radhika Nidumolu

Indian School of Business (ISB), Hyderabad

Date Written: June 30, 2018

Abstract

The development of Corporate Governance is a global phenomenon and draws significant attention of both academic and in practice. A growing body of research in this area is obvious and suggests that this new area gains relevance and its development has been affected by the theories of different disciplines. The present study mainly focuses on ‘Agency Theory’ and this theory provides theoretical framework for corporate governance. The basic assumption of this theory is that the agent is likely to be self-centered and optimistic about the chances to maximize his utility.

However, defining agency theory as a contractual relationship under which both the parties are trying to maximize their utility. If every individual behaves rationally decision making becomes difficult in the system in order to achieve common goals. The agent will not always act rationally because he must make decisions according to the preferences. Sometimes these preferences can also be turned as constraints to their rational decision making process. The agent will not always act in the best interest of the principal because of bounded rationality. The Agency costs means the costs incurred in scrutinizing and controlling the mangers and try to put off their exploitation2. These costs may be reduced by well planned approach to governance structures. The problems arising out of agent- principal relationship create governance issues and badly impact the firm’s performance. The firms which having weaker governance structures, managers of those firms acted rationally to maximize their personal benefits, because of weak corporate structures. Agency problem is not only a matter of separation of interest but also conflict of interest with in the ownership structures. The Agency problems, ownership structures’ and firms’ performance are inter-related. The ownerships structures have a significant impact on long term value and firms’ performance. Effective governance mechanisms’ can only minimize the agency costs and hold-up problems associated with separation of ownership and control. Corporate governance not only reinforces the managerial responsibility but also boosts the confidence of the managers’; to improve firm’s performance towards maximizing profits rather than pursue their own objects. This paper deals with the principal - agent problem in the stakeholder context. This study also emphasizes that good governance mechanisms can only curtail the agency, moral hazards’ and hold-up problems connected with separation of ownership and control. Generally, ownership structure is considered an important factor in determining the value of the firm. However, the empirical results of this study state the ownership structure is not an only instrument to tackle the agency related problems. But, by reducing agency costs through effective ownership mechanisms will improve firm’s economic performance.

Keywords: Agency costs, Ownership structures, Firm performance, Governance mechanisms, Stakeholders

JEL Classification: G34, G32

Suggested Citation

Nidumolu(Voleti), Radhika, Exploring the Effects of Agency Theory on Ownership Structures and Firm Performance (June 30, 2018). Available at SSRN: https://ssrn.com/abstract=3809607

Radhika Nidumolu(Voleti) (Contact Author)

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

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