agency theory corporate governance essay

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What Is Agency Theory?

Understanding agency theory, areas of dispute in agency theory, reducing agency loss.

Business Essentials

Agency Theory: Definition, Examples of Relationships, and Disputes

agency theory corporate governance essay

Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom.

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Agency theory is a principle that is used to explain and resolve issues in the relationship between business principals and their agents. Most commonly, that relationship is the one between shareholders , as principals, and company executives, as agents.

Key Takeaways

Agency theory attempts to explain and resolve disputes over the respective priorities between principals and their agents.
Principals rely on agents to execute certain transactions, which results in a difference in agreement on priorities and methods.
The difference in priorities and interests between agents and principals is known as the principal-agent problem.
Resolving the differences in expectations is called "reducing agency loss."
Performance-based compensation is one way that is used to achieve a balance between principal and agent.
Common principal-agent relationships include shareholders and management, financial planners and their clients, and lessees and lessors.

An agency, in broad terms, is any relationship between two parties in which one, the agent, represents the other, the principal, in day-to-day transactions. The principal or principals have hired the agent to perform a service on their behalf.

Principals delegate decision-making authority to agents. Because many decisions that affect the principal financially are made by the agent, differences of opinion, and even differences in priorities and interests, can arise. Agency theory assumes that the interests of a principal and an agent are not always in alignment. This is sometimes referred to as the principal-agent problem .

By definition, an agent is using the resources of a principal. The principal has entrusted money but has little or no day-to-day input. The agent is the decision-maker but is incurring little or no risk because any losses will be borne by the principal.

Financial planners and portfolio managers are agents on behalf of their principals and are given responsibility for the principals' assets. A lessee may be in charge of protecting and safeguarding assets that do not belong to them. Even though the lessee is tasked with the job of taking care of the assets, the lessee has less interest in protecting the goods than the actual owners.

Agency theory addresses disputes that arise primarily in two key areas: A difference in goals or a difference in risk aversion.

For example, company executives, with an eye toward short-term profitability and elevated compensation, may desire to expand a business into new, high-risk markets. However, this could pose an unjustified risk to shareholders, who are most concerned with the long-term growth of earnings and share price appreciation.

Another central issue often addressed by agency theory involves incompatible levels of risk tolerance between a principal and an agent. For example, shareholders in a bank may object that management has set the bar too low on loan approvals, thus taking on too great a risk of defaults .

Various proponents of agency theory have proposed ways to resolve disputes between agents and principals. This is termed "reducing agency loss." Agency loss is the amount that the principal contends was lost due to the agent acting contrary to the principal's interests.

Chief among these strategies is the offering of incentives to corporate managers to maximize the profits of their principals. The stock options awarded to company executives have their origin in agency theory. These incentives seek a way to optimize the relationship between principals and agents. Other practices include tying executive compensation in part to shareholder returns. These are examples of how agency theory is used in corporate governance.

These practices have led to concerns that management will endanger long-term company growth in order to boost short-term profits and their own pay. This can often be seen in budget planning, where management reduces estimates in annual budgets so that they are guaranteed to meet performance goals. These concerns have led to yet another compensation scheme in which executive pay is partially deferred and to be determined according to long-term goals.

These solutions have their parallels in other agency relationships. Performance-based compensation is one example. Another is requiring that a bond is posted to guarantee delivery of the desired result. And then there is the last resort, which is simply firing the agent.

What Disputes Does Agency Theory Address?

Agency theory addresses disputes that arise primarily in two key areas: A difference in goals or a difference in risk aversion. Management may desire to expand a business into new markets, focusing on the prospect of short-term profitability and elevated compensation. However, this may not sit well with a more risk-averse group of shareholders, who are most concerned with long-term growth of earnings and share price appreciation.

There could also be incompatible levels of risk tolerance between a principal and an agent. For example, shareholders in a bank may object that management has set the bar too low on loan approvals, thus taking on too great a risk of defaults.

What Is the Principal-Agent Problem?

The principal-agent problem is a conflict in priorities between a person or group and the representative authorized to act on their behalf. An agent may act in a way that is contrary to the best interests of the principal. The principal-agent problem is as varied as the possible roles of principal and agent. It can occur in any situation in which the ownership of an asset, or a principal, delegates direct control over that asset to another party, or agent. For example, a home buyer may suspect that a realtor is more interested in a commission than in the buyer's concerns.

What Are Effective Methods of Reducing Agency Loss?

Agency loss is the amount that the principal contends was lost due to the agent acting contrary to the principal's interests. Chief among the strategies to resolve disputes between agents and principals is the offering of incentives to corporate managers to maximize the profits of their principals. The stock options awarded to company executives have their origin in agency theory and seek to optimize the relationship between principals and agents. Other practices include tying executive compensation in part to shareholder returns.

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What’s Wrong With Agency Theory?

First Online: 20 November 2018

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Alexander Pepper 2

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This chapter begins by describing the standard model of the firm in organisational economics. It continues by providing a critique of the main premises on which the standard model is based: that shareholders own firms and directors are their agents; that agency costs arise at the level of the firm because of the different interests of shareholders and managers; that man is rational, self-interested, and rent-seeking and there is no non-pecuniary agent motivation. A case study of AstraZeneca is used to illustrate some of the points.

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Jensen, M., & Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3 (4) p. 310.

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Hodgson, G. (2015). Conceptualizing Capitalism: Institutions, Evolution, Future . Chicago, Ill: University of Chicago Press; Orts, E. (2013). Business persons: A Legal Theory of the Firm . Oxford: Oxford University Press.

Harris, J., Johnson, S., & Souder, D. (2013). Model-theoretic knowledge: the case of agency theory and incentive alignment. Academy of Management Review, 38 (3) pp. 442–454. Oliver Williamson quoting Allen Newell, puts it like this: “New theories rarely appear full blown but evolve through a progression during which the theory and the evidence are interactive – ‘theories cumulate. They are refined and reformulated, corrected and expanded. Thus, we are not living in the world of Popper…Theories are not shot down with a falsification bullet…Theories are more like graduate students – once admitted you try hard to avoid flunking them out…Theories are things to be nurtured and changed and built up.’” Williamson, O. (2011). Corporate governance: a contractual and organizational perspective. In L. Sacconi, M. Blair, R. Freeman, & A. Vercelli (Eds.), Corporate Social Responsibility and Corporate Governance . Palgrave Macmillan., p. 5.

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Donaldson , L., & Davis, J. (1991). Stewardship theory or agency theory: CEO governance and shareholder returns. Australian Journal of Management, 16 (1) pp. 49–64. Davis, J., Schoorman, F., & Donaldson, L. (1997). Toward a stewardship theory of management. Academy of Management Review, 22 (1) pp. 20–47.

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Jensen, M., & Murphy, K. (1990). Performance pay and top-management incentives. Journal of Political Economy, 98 (2) pp. 225–264. When Jensen and Murphy failed to find a statistically significant connection between CEO pay and performance, they argued that this was the result of political forces at the heart of the corporation and that companies should provide a greater proportion of total compensation in the form of incentive pay, thus switching from a positive to a normative line of argument. I call this the “J- twist”. Paul Samuelson (1963) described Milton Friedman’s thesis that the truth of the assumptions is irrelevant to the acceptability of a theory, provided that the theory’s predictions succeed, as the “F-twist”. Steve Keen argues that Tony Lawson provides the “L-correction” to the “F-twist” by forcing economics to consider its ontology – see Lawson ( 2015 ) postface and Chap. 3 . In the same spirit, one of the aims of this book is to point out and provide a correction to Jensen’s “J-twist”.

Tosi, H., Werner, S., Katz, J., & Gomez-Mejia, L. (2000). How much does performance matter? A meta-analysis of CEO pay studies. Journal of Management, 26 (2) pp. 301–339. Two subsequent meta-analytic reviews have continued to provide evidence that CEO pay and financial performance are not closely related: see van Essen, M., Otten, J., & Carberry, E. (2015). Assessing managerial power theory: a meta-analytic approach to understanding the determinants of CEO compensation. Journal of Management, 26 (2), pp. 164–202, and Aguinis, H., Gomez-Mejia, L., Martin, G., & Joo, H. (2018). CEO pay is indeed decoupled from CEO performance: charting a path for the future. Management Research, 16 (1), 117–136.

Frydman, C., & Saks, R. (2010). Executive compensation: a new view from a long-term perspective, 1936–2005. The Review of Financial Studies, 23(5) pp. 2099–2138. The managerial power hypothesis can be found in Bebchuk, L., & Fried, J. (2004). Pay without performance – the unfilled promise of executive compensation . Cambridge, Mass: Harvard University Press.

See Gabaix, X., & Landier, A. (2008). Why has executive pay increased so much? Quarterly Journal of Economics, 123 (1) pp. 49–100, and Edmans, A., & Gabaix, X. (2016). Executive compensation: a modern primer. Journal of Economic Literature, 54 (4) pp. 1232–1287.

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Heath ( 2014 ) points out that corporate law varies significantly from country to country and between states in the United States. This presents certain difficulties when attempting to generalise principles drawn from close legal analysis. The implications of this are examined further in Chap. 4 .

There are many references, most notably Blair and Stout ( 1999 ) A team production theory of corporate law. Virginia Law Review, 85 (2) pp. 247–328, but also including: Blair ( 1995 , 1996 ) and Stout ( 2012 ). “Team production” is a reference to the economic theory of the firm advanced by Alchian & Demsetz ( 1972 ). Blair & Stout also make reference to the conventional theory of corporate agency relationships, described in this book as “the standard model”, which they refer to as the “grand-design principal-agency model”.

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Also relevant are the five different types of property rights that have been identified (by their presence or absence) in empirical studies of common pool resources systems. These are: access , the right to enter a defined physical property; withdrawal , the right to draw an income from a common pool resource; management, the right to regulate the patterns of use of common pool resources and to transform a resource system by making investments and improvements; exclusion, the right to determine who has access and withdrawal rights; and alienation, the right to sell or lease any of the other rights – see Poteete, A., Janssen, M., & Olstrom, E. (2010). Working Together – Collective Action, the Commons, and Multiple Methods in Practice . Princeton & Oxford: Princeton University Press, p. 95. Shareholders have some (i.e., access, withdrawal, and alienation rights) but not all of these. For more on the relevance of the literature on common pool resources to public corporations, see Chap. 4 .

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Pepper, A. (2019). What’s Wrong With Agency Theory?. In: Agency Theory and Executive Pay. Palgrave Pivot, Cham. https://doi.org/10.1007/978-3-319-99969-2_2

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Agency Theory in Corporate Governance: Criticism and Real Application Coursework

Introduction, agency theory explained, agency theory criticism, three other theories, reference list.

Corporate governance is an essential phenomenon in the modern world because it has a direct connection to the sustainability of various firms and companies. In general, the given term stands for a set of rules and practices that are used to govern and control the performance of companies. If one wants to understand what this phenomenon is, it is reasonable to consider a hypothetical example. When a firm emerges, it is relatively small, and its founder fully owns it.

However, as it grows, it becomes impossible for the owner to control everything in their business. In this case, it seems suitable to consider delegating some ownership rights to professional specialists. This fact results in the separation of ownership and control, which, in turn, creates corporate governance systems that consist of two distinct groups. The first of them includes shareholders or principals, while the second one comprises managers or agents. The two groups should cooperate to achieve the best outcomes, and Owolabi (2019, p. 2) supports this idea by stating that corporate governance is holding the balance “between individual and communal goals”.

When it comes to such separation, one should emphasize the possible issues that can manifest themselves in several ways. Firstly, principals and agents can have different interests, which is the basis for conflicts between them. Secondly, an agent has a degree of autonomy, which denotes that they cannot consult with a principal before making every decision. This potential scenario means that specific governance procedures are necessary to solve the issues above.

According to the information above, it is impossible to overestimate the significance of corporate governance for individual businesses, and multiple pieces of research prove it. Firstly, Hussain, Rigoni, and Orij (2018, p. 411) have analyzed reports of numerous US-based firms and identified that strict corporate governance has a positive impact on companies’ sustainability. Secondly, Owolabi (2019, p. 1) also mentions that the effectiveness of corporate governance depends on many phenomena, including control mechanisms, compliance with relevant regulations, reliability of financial reports, and others.

The information above denotes that firms should invest in developing their governance structures and procedures. However, the data of publicly traded US firms have shown that more robust corporate governance significantly decreases companies’ innovation abilities and reduces job security (Markus and Swift, 2019, p. 91). It means that effective corporate governance should be moderate to both control business operations and provide managers with appropriate freedom of action.

Since the phenomenon under consideration is complex, it is not a surprise that various approaches exist to explain relationships within it, and agency theory is traditional among them. Even though it is a popular theory, it has faced much criticism in recent decades. Thus, the main task of the given coursework is to explain the reasons for this criticism and compare the theory to three other perspectives. Furthermore, it is reasonable to present an argument for why the agency theory will be relevant in the future of corporate governance.

To begin with, one should comment on the basics of the agency theory that is simple in its use. The given perspective denotes that there is a principal and an agent, and a contract governs a relationship between them. This agreement stipulates that an agent should perform some service or actions on behalf of a principal. Legal, financial, and moral principles support the existence of the given relationship. In the modern world, this corporate governance theory is one of the most popular ones because it is considered elementary and valid. However, empirical evidence demonstrates that the given approach has both advantages and disadvantages that will be described below.

On the one hand, the most significant advantage of the agency theory has already been presented, and it refers to the simplicity in use. Thus, principals and owners do not need to develop complex mechanisms or establish large bodies to govern their firms. Furthermore, this theory provides agents and managers with relative freedom of action, which often contributes to more productive outcomes.

These results are positive if agents share the principals’ interest, which is possible due to the norms of reciprocity and fairness (Bosse and Phillips, 2016, p. 276). Finally, mechanisms that are present in the given method can lead to lower agency costs, mainly because of a simple governance system and trust between agents and principals (Panda and Leepsa, 2017, p. 74). This positive result means that the profits of an appropriate firm become higher, and this fact is attractive to both agents and principals.

On the other hand, it is necessary to present the disadvantages of the theory under consideration. Firstly, Panda and Leepsa (2017, p. 74) stipulate that the agency perspective results in a problem when there is a conflict of interest between an agent and a principal. This negative effect appears because of the autonomy that is given to agents. In this case, they are free to follow their own interest in some situations because principals do not strictly supervise their actions and decisions. Secondly, one should mention that a higher possibility of financial fraud is another adverse consequence of agency theory.

According to Shi, Connelly, and Hoskisson (2017, p. 1268), this misconduct is caused by external governance mechanisms, including “activist owners, the market for corporate control, securities analysts” and others. Since the external pressure above is limited, it only agitates agents’ intrinsic motivation to participate in financial malpractice (Shi, Connelly, and Hoskisson, 2017, p. 1268). Finally, Pouryousefi and Frooman (2017, p. 163) indicate that it is impossible to benefit from the agency theory “in the absence of ethical behavior”. The success of agency theory significantly depends on the fairness of agents.

The information above has demonstrated that the same principles of the agency theory lead to both positive and negative outcomes. Thus, the provided autonomy results in both product performance and the potential for financial fraud. At the same time, the absence of various governance mechanisms and reporting systems is suitable for all the parties, but it results in the fact that principals cannot monitor agents’ actions. This phenomenon, in turn, can lead to the fact that agents follow their own interests or behave unethically in some cases. The given scenario is known as opportunistic behavior when agents work against the welfare of principals.

According to the information above, there is no doubt that agency theory is a controversial phenomenon. All the disadvantages justify the criticism that has reached the given perspective over the past decades. The ideas that will be presented below are going to explain that the critical points of view are based on multiple aspects. They include theoretical implications, the role of a board of directors, financial issues, ethical considerations, and others. This criticism will show that it is necessary to consider other corporate governance theories to identify their potential impact on the firm’s performance and sustainability.

Narrow Theoretical Scope

Firstly, one of the main reasons that doubt the effectiveness of the agency approach refers to its narrow theoretical scope. There is a significant number of research articles concerning the effectiveness of the agency theory, but they often draw attention to a limited set of conditions and concomitant factors. It refers to the fact that the essential part of research only analyses the use of the given approach in the context of developed countries, including the US and the UK. However, when it comes to smaller businesses in both developed and developing nations, the results can be significantly different.

Vargas-Hernández and Cruz (2018) support the idea above by focusing on the Mexican market. The researchers consider the case of Megacable, Mexico’s largest internet and telephony provider, and show that the agency perspective can help achieve faster growth. It is possible because of “the distribution of rights and responsibilities among the different participants of the company” (Vargas-Hernández and Cruz, 2018, p. 67).

At the same time, the scholars stipulate that in Mexico, small and medium enterprises that are owned by family members represent a significant part of all businesses. In this context, it is a typical case when agents and principals are relatives, which can result in some issues. For example, low-skilled individuals can become agents, and it leads to general incompetence and potential fraud (Vargas-Hernández and Cruz, 2018, p. 62). There is little research on the topic, and it is challenging to answer how to address the issue. Consequently, agency theory criticism is based on the fact that it is not explained how it is possible to benefit from the perspective under consideration in all environments.

Board of Directors Structure

Secondly, one should state that the board of directors stands for another source of criticism. This body acts as an intermediary between principals and agents, and “it is responsible for ratifying and evaluating strategic decisions” (Vargas-Hernández and Cruz, 2018, p. 62). Consequently, it necessarily implies the performance and sustainability of a firm or company. Even though Yusof (2016, p. 156) argues that the conduct of directors determines the effectiveness of the body, it is reasonable to draw attention to its structure. The presence of independent or external directors is useful for a company as they tend to perform their functions impartially, which is possible because they are given the director’s compensation.

Thus, one can say that the board of directors is a supervisory body of principals who hire specialists to make the shape the activity of agents. When the directors perform their functions diligently, the company’s performance improves. However, criticism emerges when it comes to the fact that directors, both internal and external, require additional remuneration. That is why critical points of view stipulate that the agency theory loses its advantages because it is necessary to invest in the creation of other bodies to monitor the activity of individuals.

Financial Issues

Thirdly, the financial side also represents an essential aspect of the problem under consideration. As has been mentioned above, it manifests itself in the necessity to reward directors, which implies higher governance costs. It means that owners should spend more to contribute to the better performance of their businesses. However, relevant financial issues also characterize a direct principal-agent relationship without any intermediaries. It refers to the fact that principals can use economic incentives to make their agents work better (Vargas-Hernández and Cruz, 2018, p. 61). Furthermore, Vargas-Hernández and Cruz (2018, p. 61) emphasize a direct connection between the expected amount of remuneration and the company’s profit. Thus, if a firm owns more, agents also want to obtain higher compensation.

The information above represents a significant basis of agency theory criticism. It is so because the given perspective aims at reducing agency costs, which has been mentioned above. However, the case with economic incentives demonstrates that it is challenging to achieve this result. It relates to the fact that money remains the most effective way to influence individual activity. Thus, one can suppose that if agents do not receive the desired amount of remuneration, the agency theory will not be useful. This fact demonstrates that it is a typical scenario when agents and principals have different interests.

In this case, money is considered the only asset that can be utilized by principals to shape and direct the activity of agents. Consequently, the idea behind the notions above is that the agency theory faces criticism because it requires extra financial resources to be an effective governance system.

Ethical Considerations

In addition to that, it is reasonable to draw attention to criticism that is based on moral issues. As has already been mentioned, the effectiveness of the agency perspective significantly depends on the fairness of agents, which draws essential attention to their ethics. Thus, severe problems for companies arise when agents pursue their own ends. However, this situation becomes even more substantial, considering the following aspect.

Yusof (2016, p. 156) stipulates that “who owns the firm’s matter for the firms’ strategies, objectives and performance”. It denotes that an owner’s identity can be one of the most significant advantages of a company. At the same time, if agents fail to follow high moral standards, the productive outcomes of the given phenomenon disappear. That is why this piece of criticism can both reduce the effect of the existing advantages and create additional problems, including, for example, financial fraud.

Other Issues

Finally, one should comment on a few more factors that contribute to agency theory criticism. On the one hand, it relates to the issue that has already been discussed. The given perspective significantly relies on the fact that principles and agents have the same interest. As practice shows, however, opposite scenarios are often, and when the agent’s self-interest overweighs that of a principal, appropriate problems for the company arise. On the other hand, one should stipulate that the agency approach is simplistic in practice. It relates to the fact that many modern companies have complex governance structures, and the agency theory fails to reflect these systems with numerous relationships within them.

The information above has shown that agency theory has multiple reasons for criticism. These issues refer to various fields, and each of them can substantially decrease the performance of a company or firm. There exist two possible solutions to the situation under consideration. On the one hand, firms can accept the risks of the given approach and do their best to minimize the potential harmful effects. On the other hand, it is possible to replace the agency theory with an alternative variant. Numerous corporate governance theories support the effectiveness of the latter step. Consequently, three additional theories will be described below to compare them to the agency perspective.

As has been mentioned above, no single theory can be sufficient to describe corporate governance. Furthermore, the agency perspective faces much criticism, which supports the idea to consider other approaches that can be useful to explain corporate governance relationships within a firm. That is why three theories, including stewardship, stakeholder, and institutional ones, will be presented further to determine whether they offer some significant advantages in comparison with the agency method.

Stewardship Theory Explained

The given perspective focuses on the fact that managers can act as stewards. According to Madlhani (2017, p. 13), this theory “acknowledges the existence of a relationship built upon trust between the shareholder and management”. It denotes that managers are considered trustworthy individuals, which allows them to act as stewards. Furthermore, Madlhani (2017, p. 13) stipulates that the perspective is useful for a firm because it is not required to split the dual role of CEO and chairman.

This duality makes it possible for the company to save some agency costs. In addition to that, the stewardship theory envisages that monitoring and financial compensations are not necessary because stewards have the same interest as shareholders (Chrisman, 2019, p. 1052). Consequently, shareholders only have the possibility to use their skills and expertise to influence company strategy (Madlhani, 2017, p. 10). As for the effectiveness of the given perspective, Joslin and Müller (2016, p. 613) indicate that it leads to more successful projects.

The positive results above are possible because of the assumption that stewards are self-actualizing and other-serving rather than self-interested (Chrisman, 2019, p. 1052). It means that these individuals tend to subsume their personal opinions to meet corporate objectives. As a result, managers and owners have shared goals, which contributes to the overall better performance of a business (Zhang et al., 2018, p. 88).

This information addresses some of the agency theory’s essential issues, including opportunistic behavior and high agency costs. Thus, the stewardship perspective seems to be more effective compared to agency one because the former means that stewards are willing to meet the specified goals without excessive financial remuneration. That is why the two approaches are considered alternative and even competing perspectives (Schillemans and Bjurstrøm, 2019, p. 1). However, this scenario is idealistic because it is a rare case when managers are ready to follow corporate goals without regard to their personal interests. That is why one can conclude that the given theory lacks realism and relevance to identify corporate governance relationships, which mitigates the impact of its advantages.

The Basics of Stakeholder Theory

The stakeholder perspective represents an alternative look at what makes firms exist and operate. Since the previous theories focused on generating shareholder value, the given approach states that it is also essential to benefit stakeholders. In the research field, there are many definitions of this term. According to Miles (2017, p. 24), stakeholders can be individuals, groups, or even entities that have an opportunity to influence the company’s performance and be impacted by its activity. This ambiguous definition reflects complex relationships that are the basis of the theory under consideration.

Collective efforts of all stakeholders are determined to influence the value creation, and the most productive outcomes are achieved when stakeholders have shared goals with a company (Freudenreich, Lüdeke-Freund, and Schaltegger, 2019, para. 15). Lange and Bundy (2018, p. 365) support this idea and emphasize that the given approach has a strong moral foundation because it is necessary to consider the interests of various people and entities.

At the same time, this approach faces a portion of criticism. Firstly, it is because of the ambiguity of its central concept (Miles, 2017, p. 39). If it is challenging to present a clear and concise definition of stakeholders, it is not a surprise that the basics of this approach also face some doubts. Secondly, this perspective stipulates that the primary purpose of any company is to meet stakeholders’ needs (Narbel and Muff, 2017, p. 1357).

However, Schaltegger, Hörisch, and Freeman (2019, p. 191) stipulate that the problem arises since the firm’s activity only creates benefits for a single group of stakeholders. Thus, it is almost impossible to meet the interests of all stakeholders at the same time. Finally, the perspective under consideration relies on regulation to minimize the adverse effects of market failures (Narbel and Muff, 2017, p. 1363). It denotes that those stakeholders who create the externalities should bear their cost, which results in unhealthy segregation within a business.

When compared to agency theory, the stakeholder perspective is peculiar because it focuses on meeting stakeholders’ needs instead of increasing shareholder value. Since there are various groups of stakeholders, it is challenging to meet the multiple interests of each of them. Consequently, the agency approach seems to be more realistic when it becomes necessary to describe the principles of corporate governance and various relationships that comprise it.

Institutional Theory Explained

As distinct from the previously described approaches, the institutional perspective draws attention to the external environment and how it can influence firms’ corporate governance. Thus, the institutional environment refers to history, culture, capital markets, political systems, and others. Even though these phenomena do not have a direct impact on a business, they can influence governance relationships. Miras- Rodríguez, Martínez- Martínez and Escobar-Pérez (2018, p. 4) state that the approach under consideration helps understand firm strategies and managerial choices.

Ferri (2017, p. 24) explains that companies should draw significant attention to different institutional settings because they imply various rules, norms, and values. Furthermore, it is necessary to consider the institutional environment “to illuminate the issue of regulatory effectiveness in changing corporate behaviour” (Chiu, 2019, p. 87). Chiu (2019, p. 85) also argues that this perspective is common in the UK. In addition to that, Briano-Turrent and Rodríguez-Ariza (2016, p. 63) stipulate that multiple institutional factors positively influence corporate governance ratings in developing countries.

However, one should stipulate that the effectiveness of the institutional approach implies a few limitations. On the one hand, the given method does not draw significant attention to the internal structure of organizations, focusing on its environment (Dolan and Connolly, 2018, p. 139). Thus, the firm’s performance is determined by the rules and norms that are present in a particular environment. On the other hand, the effectiveness of the institutional perspective depends on the level of rule-based trust in society. Alon and Hageman (2017, p. 155) say that when it is high, companies are less likely to suffer from corruption irrespective of the environment.

As has been mentioned, all the theories above can be used to describe the principles of corporate governance, and none of them is free from limitations. That is why there arises a question of which perspective is more relevant in the modern world. The following information will try to prove that the traditional agency perspective is still valid and appropriate in the field of corporate governance.

Firstly, one of the leading agency theory advantages refers to the fact that it implies a clear and straightforward governance structure that comprises principals and agents. There is no need to establish large bodies that will make it possible to rule businesses. At the same time, the perspective under consideration draws attention to the fact that principals and agents can have different interests concerning some issues, which can result in opportunistic behavior. Its possible adverse effect is mitigated with the help of financial remuneration systems. This perspective requires essential economic resources, but this fact reflects the real state of affairs. Consequently, this theory is more relevant than the stewardship perspective because the latter is based on an idealistic view that there is a constant consensus between owners and managers.

Secondly, the agency approach is also suitable for current conditions because it does not aim at meeting all stakeholder’s needs. When it comes to governing a business, it can comprise multiple stakeholder groups, and each of them implies its appropriate interests. It is impossible to satisfy their needs without harming a company. That is why the focus should be placed on achieving the best outcomes, which is possible by meeting the corporate goals. It has been described that principals are one of the main factors that determine the successful performance of a firm. Thus, agents act as useful tools to reach the specified targets, which means that the agency perspective is relevant since it allows to achieve positive outcomes.

Thirdly, the agency approach is more relevant than the institutional one because the latter draws attention to the external conditions of business. There is no doubt that this environment is essential, but it is more reasonable to focus on internal relationships. Alon and Hagemann (2017, p. 155) support this idea by mentioning that trust between individuals is significant for determining the effectiveness of the institutional approach. Thus, it is more useful to consider the real relationships between various agents and principals to understand the main concepts that represent the basics of corporate governance structures.

Corporate governance is a complicated and essential phenomenon that describes how various companies are ruled. Since it has a complex nature, multiple theories try to explain how corporate governance works. Each of them implies its own assumptions and limitations that are the basis for criticism. Even though each perspective has some defects, it is possible to compare all of them to identify one that is more relevant than the others.

The given method has demonstrated that the agency perspective is appropriate in the modern world. Even though the presented approach is highly criticized, it is still useful because it is based on working and straightforward principles. Furthermore, the given theory relies on financial compensation, which allows achieving the most productive results.

Alon, A. and Hageman, A. M. (2017) ‘An institutional perspective on corruption in transition economies’, Corporate Governance: An International Review, 25(3), pp. 155-166.

Bosse, D. A. and Phillips, R. A. (2016) ‘Agency theory and bounded self-interest’, Academy of Management Review, 41(2), pp. 276-297.

Briano-Turrent, G. d. C. and Rodríguez-Ariza, L. (2016) ‘Corporate governance ratings on listed companies: an institutional perspective in Latin America’, European Journal of Management and Business Economics, 25(2), pp. 63-75.

Chiu, I. H.-Y. (2019) ‘An institutional theory of corporate regulation’, Northwestern Journal of Internaltional Law & Business, 39(2), pp. 85-170.

Chrisman, J. J. (2019) ‘Stewardship theory: realism, relevance and family firm governance’, Entrepreneurship Theory and Practice, 43(6), pp. 1051-1066.

Dolan, P. and Connolly, J. (2018) ‘Beyond logic and norms: a figurational critique of institutional theory in organisation studies’, Cambio, 7(14), pp. 139-149.

Ferri, L. (2017) ‘The influence of the institutional context on sustainability reporting: a cross-national analysis’, Social Responsibility Journal, 13(1), pp. 24-47.

Freudenreich, B., Lüdeke-Freund, F. and Schaltegger, S. (2019) ‘A stakeholder theory perspective on business models: value creation for sustainability’, Journal of Business Ethics. Web.

Hussain, N., Rigoni, U. and Orij, R. P. (2018) ‘Corporate governance and sustainability performance: analysis of triple bottom line performance’, Journal of Business Ethics, 149, pp. 411-432.

Joslin, R. and Müller, R. (2016) ‘The relationship between project governance and project success’, International Journal of Project Management, 34(4), pp. 613-626.

Lange, D. and Bundy, J. (2018) ‘The association between ethics and stakeholder theory’, in Dorobantu, S. et al. (eds.) Sustainability, stakeholder governance and corporate social responsibility. Bingley: Emerald Publishing Limited, pp. 365-387.

Madlhani, P. M. (2017) ‘Diverse roles of corporate board: review of various corporate governance theories’, The IUP Journal of Corporate Governance, 16(2), pp. 7-28.

Markus, A. and Swift, T. (2019) ‘Corporate governance and the impact to the R&D lab’, Journal of Strategy and Management, 13(1), pp. 91-110.

Miles, S. (2017) ‘Stakeholder theory classification, definitions and essential contestability’, in Wasieleski, D.M. and Weber, J. (eds.) Stakeholder management. Bingley: Emerald Group Publishing, pp. 21-48.

Miras- Rodríguez, M. d. M., Martínez- Martínez, D. and Escobar-Pérez, B. (2018) ‘Which corporate governance mechanisms drive CSR disclosure practices in emerging countries?’ Sustainability, 11(61), pp. 1-20.

Narbel, F. and Muff, K. (2017) ‘Should the evolution of stakeholder theory be discontinued given its limitations?’ Theoretical Economics Letters, 7, pp. 1357-1381.

Owolabi, S. A. (2019) ‘Quality accounting service a panacea to effective corporate governance’, Society for Corporate Governance Nigeria, pp. 1-23.

Panda, B. and Leepsa, N. M. (2017) ‘Agency theory: review of theory and evidence on problems and perspectives’, Indian Journal of Corporate Governance, 10(1), pp. 74-95.

Pouryousefi, S. and Frooman, J. (2017) ‘The problem of unilateralism in agency theory: towards a bilateral formulation’, Business Ethics Quarterly, 27(2), pp. 163-182.

Schaltegger, S., Hörisch, J. and Freeman, R. E. (2019) ‘Business cases for sustainability: a stakeholder theory perspective’, Organisation & Environment, 32(3), pp. 191-212.

Schillemans, T. and Bjurstrøm, K. H. (2019) ‘Trust and verification: balancing agency and stewardship theory in the governance of agencies’, International Public Management Journal, pp. 1-35.

Shi, W., Connelly, B. L. and Hoskisson, R. E. (2017) ‘External corporate governance and financial fraud: cognitive evaluation theory insights on agency theory prescriptions’, Strategic Management Journal, 38(6), pp. 1268-1286.

Vargas-Hernández, J. and Cruz, M. E. T. (2018) ‘Corporate governance and agency theory: Megacable case’, Corporate Governance and Sustainability Review, 2(1), pp. 59-69.

Yusof, N. Z. M. (2016) ‘Context matters: a critique of agency theory in corporate governance research in emerging countries’, International Journal of Economics and Financial Issues, 6(S7), pp. 154-158.

Zhang, F. et al. (2018) ‘Roles of relationships between large shareholders and managers in radical innovation: a stewardship theory perspective’, The Journal of Product Innovation Management, 35(1), pp. 88-105.

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Agency theory and corporate governance A study of the effectiveness of board in their monitoring of the CEO

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30 Multiple Agency Theory: An Emerging Perspective on Corporate Governance

Robert E. Hoskisson currently holds the George R. Brown Chair of Management at the Jesse H. Jones Graduate School of Management at Rice University, United States. His research focuses on: corporate and international diversification strategies; governance and innovation, and entrepreneurship; acquisitions and divestitures; business groups and strategies of emerging economy firms; and cooperative strategy. Professor Hoskisson's research has been published widely in top management journals and he has co‐authored over twenty books. He is currently an Associated Editor of the Strategic Management Journal as well as serving in a number of other editorial roles or as a board member at other journals. He is a Fellow of the Strategic Management Society and the Academy of Management.

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Published: 01 July 2013
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This chapter studies the problem of multiple agent conflicts. It states that majority of ownership is taken from institutional investors who are also agents to ultimate principals. It studies the dual identities of these institutional investors—who are also called “agent-owners”—and introduces the multiple agency theory. It then expands this theory though an analysis of the potential conflicts and effects caused by agent-owners and other relevant governance actors.

Introduction

Agency theory is a powerful model that serves as the basis for much of the corporate governance literature. But, like all models in the social sciences, agency theory presents a simplified version of reality. At its most rudimentary level, agency models consist of one agent and one principal with a contracting relationship tying them together (Jensen and Meckling, 1976 ). In this model, neither agent nor principal maintains other contracting relationships. Indeed, each has a singular identity as principal or agent, with the loyalty of the agent due completely to the principal, and any efforts or resources the principal wishes to expend devoted completely to the agent. However, beyond the fact that each has a singular identity, in this model principal and agent have no outside relationships. The only connection that exists is with the contracting partner. Neither principal nor agent has outside affiliations that might influence his or her behavior. Finally, this simple agency model does not have a strong sense of temporality. While there is some possibility of change in the contract (i.e. if the agent is let go for poor performance), the general sense is that the contracting period is indefinite, with both principal and agent largely acting as if they expect to be in the relationship for the long term.

Naturally, reality does not correspond well to the simplest agency models with their emphasis on singular identities, a lack of outside relationships, and a weak sense of temporality. Take, for instance, the notion of a single unified principal, or owner. Over the past several decades there has been a move toward increased complexity in the ownership structure of public corporations with the rise of institutional investors. Currently, over 70 percent of the ownership in large US firms is managed by institutional shareholders (Gillan and Starks, 2007 ). This same trend toward institutional ownership is progressing throughout the world (Goyer and Jung, 2011 ). As a result, we have a new class of “agent-owners”—principals in the traditional agency sense of the term—who collect investment capital from “ultimate principals” and then act on their behalf to invest that capital (see Figure 30.1 ). This pattern is also followed by private equity firms, hedge funds, venture capitalists, and other institutions, all of whom serve simultaneously as principal to the firms in which they hold ownership and yet as agent to those individuals and entities who have invested with them. Our chapter aims to extend agency theory by reflecting the increased variety of interests between managerial agents, agent-owners, ultimate principals, and other contracting parties that play important roles in the new governance landscape.

Layered relationships and embedded agency in the modern organization

Our extension of agency theory identifies an increasing number of interests which often conflict with one another. No longer is there potential divergence of interest merely between principal and interest, but among a web of interrelated parties. As noted in Arthurs et al. ( 2008 : 277): “Traditional agency theory examines conflicts of interest between a principal and agent; multiple agency theory examines conflicts of interests among more than one agent group when at least one of those agents is connected to a different principal.” Instead of addressing a one-to-one relationship, multiple agency theory examines a many-to-many relationship to explain outcomes. Such settings create both a potential for “conflicting voices” among the various principal groups (Hoskisson et al., 2002 ), and also a situation in which each agent may face conflicting choices concerning which principals’ interests will be served.

Our work builds on the research of others who have elaborated very effectively on the basic agency model. For example, principal–principal agency theory focuses on conflicts among firm principals and appropriation of one principal by another. This can occur, for instance, when family owners dominate minority owners in emerging economies, where investment rights and minority shareholders are not well protected (Chang, 2003 ). However, multiple agency theory goes beyond this basic conflict between principals, which is already established in the literature. The aspiration of this chapter ultimately is to develop a more general application of multiple agency theory where a number of settings are represented. The multiple agency framework has already been introduced into initial public offerings (IPOs) by the work of Arthurs and colleagues ( 2008 ). In addition to informing this context more fully with multiple agency theory, we also propose that the theory might be useful in research addressing mergers and acquisitions, joint ventures, leveraged buyouts, and bankruptcy situations.

The particular arguments set forward in this chapter will seek to make clear that multiple agency theory may be useful in understanding events where significant changes in a firm's capital providers are taking place. These changes usually highlight the different interests of the managerial agents and the agent-owners involved. Ultimately, it is hoped that this perspective will also incorporate multiple agent interests in broader contexts (such as those noted above) as well as dynamics and processes that are not part of traditional agency theory, which is generally static in nature.

Conflict between Owner-Agents

Perhaps the best starting point is to examine the work of Jensen and Meckling ( 1976 ). Most of the work using traditional agency theory in the corporate governance literature has examined the conflict between managerial agents and diffused principals. There are numerous examples in the literature of this type of principal–agent conflict which the seminal work of Jensen and Meckling originally described. However, there is a growing body of literature which addresses the issue of ownership heterogeneity and how different owner groups can conflict regarding issues of firm strategy.

A significant amount of the work on owner heterogeneity has been done in the area of internal innovation. Kochhar and David ( 1996 ) found that pressure-resistant agent-owners, or agent-owners who are independent of possible pressure from customer groups (e.g. pension funds), are positively related to expenditures on firm innovation. Similarly, from the accounting literature, Bushee ( 1998 ) found that transient owners (those that hold onto their stock for a relatively short time frame) are likely to cut R&D expenditures. As such, they suggest that firms with these types of owners have shorter investment time horizons. Alternatively, those firms that have active owners, usually pension fund owners, have higher relative R&D than other firms. Hoskisson et al. ( 2002 ) suggest that pension funds had a stronger preference for internal innovation than did mutual funds. Finally, Zahra ( 1996 ) found that ownership by long-term investors was positively related to corporate entrepreneurship. In total, these studies are indicative of potential conflict between various agent-owners with different preferences toward innovation and toward the expenditures necessary to pursue that innovation.

In addition to work in the area of innovation, there is a body of research tying the time horizon of certain owners with investments in corporate social responsibility. For example, Johnson and Greening ( 1999 ) found that pension fund holders were more likely than mutual fund holders to be associated with firms that invested in corporate social responsibility. This was echoed in later work by Cox et al. ( 2004 ) which produced similar results. Neubaum and Zahra ( 2006 ) found that not only did corporate social responsibility increase with long-term investors, but the relationship grows stronger as the activism of these long-term investors increases. Activism suggests that they are more involved in the content of corporate strategy, such as R&D expenditures, commitment to innovation, and corporate social responsibility (for further discussion of the relationships between corporate governance and corporate social responsibility see Chapter 32 of this volume). All of these strategies take time to implement because of the effort required to build the needed internal culture and external reputation. Pension funds, which are generally a more patient type of capital, are often more amenable to this approach.

The literature has also examined other ways in which firm strategies are impacted by the composition of the firm's ownership. For example, Connelly, Tihanyi, et al. ( 2010 ) found that transient owners are likely to constrain executive decision-making to tactical (versus strategic) moves that are likely to enhance short-term quarterly earnings reports. On the other hand, longer-term owners are more likely to allow strategic moves. Woidtke ( 2002 ) found that substantial pension fund ownership in firms is positively related to firm growth, while international expansion is found to be related to pension fund ownership by Tihanyi et al. ( 2003 ). Tihanyi and colleagues ( 2003 ) also found that there is alignment between pension fund holders and inside directors who tend to be more long term in their orientation. Interestingly, Bushee and Noe ( 2000 ) found that short-term investors such as retail mutual fund holders who hold a firm's stock for less than a year prefer frequent disclosure. Such a high volume of disclosure exacerbates stock price volatility. Finally, Bushee ( 2001 ) found that short-term institutional investors prefer to examine short-term earnings and are often associated with mispricing of equity ownership. The upshot of this research is that differences of opinion among owners can lead to significant conflict regarding firm strategy. Because substantial ownership heterogeneity exists in many firms (Bennett et al., 2003 ), we should not be surprised to find such conflicts playing out on a regular basis.

Given the ubiquity of conflict in various settings, we will show how multiple agency insights extend insights from traditional agency theory. In the following section we discuss how multiple agency theory builds upon traditional agency theory. We begin by discussing the elements creating agency conflicts. We then show how dual identities, transcending relationships, and investment time horizon differences can create goal conflict in a multiple agency setting. Given the importance of the specific context in explaining the nature of multiple agency conflicts, we will extend multiple agency theory to a variety of situations, including IPOs, mergers and acquisitions, joint ventures, leveraged buyouts, and bankruptcies.

Multiple Agency Theory—Sources of Conflict

In a traditional agency situation, a principal who employs an agent faces potential agency conflicts owing to the information asymmetry between the two and due to potentially conflicting goals (Eisenhardt, 1989 ). The traditional agency problem is often illustrated with the CEO who engages in opportunism by doing things such as purchasing excessive perquisites (Jensen and Meckling, 1976 ) or seeking unprofitable growth through acquisitions and overdiversifying the organization. These things tend to reduce the CEO's employment risk owing to the smoothing of cash flows (Amihud and Lev, 1981 ). However, the costs of these opportunistic acts are borne by the principals. To overcome this problem, principals utilize monitoring and incentives to reduce information asymmetry and help align the goals of the agent with those of the principal. While monitoring and incentives can be costly, they are established in the hopes of ameliorating more expensive agency problems a priori.

Although multiple agency theory and traditional agency theory share the same assumptions concerning human nature and the potential for agent self-interest-seeking behavior (Williamson, 1996 ), three elements distinguish the two theories. These three elements indicate the sources of conflict arising in any specific multiple agency context. First, at least one of the parties in the focal situation faces a dual identity (Pratt and Foreman, 2000 ). One way this could occur is through a principal also serving as agent to principals beyond the focal situation. For example, in the IPO setting, venture capitalists typically serve as principals to the firms they invest in, but they are also agents to the investors in their venture capital fund. Dual identity could also exist when an agent in the focal situation serves as agent to other principals beyond the focal relationship. For example, the underwriter in an IPO deal is the agent to the issuing firm, but is also an agent to institutional investors who purchase shares. This dual identity creates an implicit tension for the actor and can generate conflicting interests. Second, when some actors in the focal situation maintain a relationship which transcends that situation, incentives for favoring the transcending or ongoing relationship create potential goal incongruence among the actors in the focal situation. This may occur, for example, between venture capitalists and underwriters. These two parties have an incentive to maintain a longer-term relationship which transcends (and can undermine) the focal IPO deal. Third, when the relationship among some actors transcends the focal situation, these types of relationships can lead to differing investment horizons which can not only interfere with appropriate incentives, but also undercut current responsibilities. Here again, the venture capitalists in an IPO deal face an implicit undermining of their oversight as principals because of their relationship with the underwriter and their short investment horizon in the IPO firm.

Having provided an overview of how multiple agency theory differs from traditional agency theory, we will elaborate on these issues and inform these differences with specific examples from various contexts. We will provide a brief description of each context and then discuss when sources of multiple agency conflict may arise in each particular setting. While some settings exhibit all three forms of potential conflict, others do not. We begin with the IPO context.

Multiple Agency Theory in the Initial Public Offering Context

While the IPO has been researched extensively in finance (Jenkinson and Ljungqvist, 2002 ) and entrepreneurship (Daily, Certo, et al., 2003 ), it is becoming an increasingly important topic of research in strategic management and other fields (Certo et al., 2001 ; Bruton et al., 2010 ). The IPO is an important event in the life of a new venture as it transitions from being a privately held company to a publicly traded firm. Most IPO companies have enjoyed a modicum of early success, and the IPO allows them to raise significantly more capital for such things as new technology and product development, paying down previous debt, expansion of the asset base, and so forth (Leone et al., 2007 ). In a typical IPO, the new venture hires an investment banker (underwriter) to float the shares of stock. The underwriter sells the shares to a group of institutional investors at the offer price and then any leftover shares are offered on the open market on the first day of trading (Pollock et al., 2004 ). Most IPOs experience significant underpricing, which is typically calculated as the difference between the offer price of the stock on the first day of trading and its higher closing price. This underpricing represents money “left on the table” by the IPO firm and reduces the total amount of capital raised by the new venture (Loughran and Ritter, 2002 ).

Information asymmetry is a common element in most of the theories used to explain the existence of IPO underpricing (Rock, 1986 ). While information asymmetry would seem to justify underpricing, the nature of the deal network tends to undermine pure information asymmetry for potential buyers as a logical reason for underpricing (Pollock et al., 2004 ). More specifically, the various actors in the process each have potentially conflicting goals based on their dual identities, the relationships they maintain beyond the IPO process, and their investment horizons.

Sources of Multiple Agency Conflict in the Initial Public Offering Context

From a multiple agency perspective, the main actors in the IPO process typically include the board members of the IPO firm (particularly insiders who are employed by the firm), venture capitalists who have provided funding for the venture and who also occupy positions on the board of directors, the investment banker who is underwriting the shares, and institutional investors such as pension funds or mutual funds who agree to buy shares from the investment banker at a pre-specified offer price.

Although the investment banker (underwriter) is the agent (to the issuing firm) in the IPO deal, each of the other actors maintains its own agency beyond the focal situation. For example, the insiders on the board of directors are agents within the firm to current and future shareholders. Venture capitalists (VCs) are agents to those institutions and wealthy individuals who have invested in the VCs’ funds. The investment banker maintains an agency to the institutional investors who are purchasing the shares of the IPO firm. The dual identity of each of these parties creates tension for each actor to decide which identity will supersede, particularly if the identities can have conflicting goals.

In the case of the insiders on the board, their agency beyond the focal IPO deal makes them better principals and monitors of the underwriter. Recent research has confirmed their efficacy in this role (Arthurs et al., 2008 ). Since they have an employment with the focal firm, they have an incentive to ensure that it raises as much money from the offering as possible. This employment naturally leads to a transcending relationship with current and future shareholders of the IPO firm and is also associated with a longer investment horizon. So, in each case, the insiders’ identities lead to unified internal goal congruence, their transcending relationships do not conflict with their goal in the IPO process (to raise as much capital as possible), and their investment horizon also supports this goal in the IPO process.

While insiders’ identities, transcending relationships, and investment horizon are associated with uniform goal congruence, the same cannot be said for VCs. Although VCs are principals to the underwriter in the IPO process, their agency to their fund shareholders can potentially lead to goal conflict. More specifically, because VC funds maintain a short lifespan (typically five to ten years) (Sahlman, 1990 ), they face pressures to show returns quickly. This situation might not normally induce goal conflict if each of the new ventures in which VCs have invested is successful. But because VCs are compensated based on the amount of capital under investment (charging their fund investors a management fee), they have a strong incentive to avoid writing off bad investments until they can show higher returns with some of the other investments (Kunze, 1990 ). The problem here is that VCs have a strong incentive to obtain close ties with reputable underwriters so that they can take new ventures through the IPO as soon as possible (Gompers, 1996 ). These ties (transcending relations) become valuable to both the VC and the underwriter since they represent future deals and income associated with those deals. These ties build trust between the two parties and communicate to the underwriter that the ventures the VC brings for IPO are of high quality. Like the dual identity of VCs, this transcending relationship with underwriters works against the best interests of the firm. Additionally, VCs’ investment horizon becomes much shorter at the time of the IPO (Dalziel et al., 2011 ). In sum, these issues contribute to an undermining of the VCs’ motivation to provide strong oversight and monitoring as a principal in the IPO process and lead to a lack of goal unity and subsequent multiple agency conflict.

Underwriters are agents in the focal IPO process, and they also maintain an agency with the institutional investors to whom they market and sell the shares (Pollock et al., 2004 ). Unfortunately for the IPO firm, underwriters have a clear incentive to favor their agency with institutional investors because, in pleasing these serial investors in IPO offerings, underwriters reduce the effort it takes to sell future shares. This preference for favoring institutional investors comes at the expense of the IPO firm. Indeed, Pollock ( 2003 ) found, that as underwriter deal network embeddedness increased, underpricing increased as well. The problem here is that the underwriter rarely will maintain a future relationship with the IPO firm. Although a seasoned equity offering deal (offering additional shares of the firm for sale in the future) is possible, it is unlikely (Jenkinson and Ljungqvist, 2002 ). Additionally, since the underwriter by nature maintains a short investment horizon, the lack of any future relationship with the IPO firm makes it difficult to maintain goal congruence. In sum, underwriters, as agents to the new venture, may lack goal congruence from a traditional agency perspective. However, their multiple agency (i.e. their agency to their institutional investors) creates even more severe goal incongruence between the underwriter and the new venture.

Multiple Agency Theory in the Mergers and Acquisitions Context

Mergers and acquisitions are an important part of the global economy (Thomson Reuters, 2011 ). While the IPO is viewed as a positive event in the life of a venture, the same is not always true for mergers and acquisitions (M&A). A merger occurs when one company absorbs another. An acquisition differs from a merger in that one company purchases the voting stock of a target firm and eventually tenders an offer to the target shareholders. Because an acquisition often bypasses the target's board of directors or management, it can be seen as “hostile” and can result in proxy contests in an attempt to get control of the target's board of directors (Ross et al., 1996 ). Tender offers can also result in two-tier offers wherein the acquiring firm tenders an offer at a significant premium to those who will sell immediately. Later, after acquiring a controlling interest, the acquiring firm may offer a reduced price to remaining shareholders (Sundaramurthy and Rechner, 1997 ).

While agency theory has been used extensively to explain the motivation and outcomes for M&A activity, multiple agency theory has applicability to the context in several different ways. Because the M&A process can be quite complex, the use of investment bankers by the acquiring firm (and even the target firm) is not unusual (Hayward, 2003 ). This use of professionals creates problems because monitoring on the part of principals becomes much more difficult when the agent is a professional (Sharma, 1997 ). Additionally, investment bankers often have internally conflicting interests as it relates to the M&A deal because these investment banks have both a corporate finance arm whose revenue is driven by generating client M&A deals as well as a security analyst arm which provides independent advice to investors about securities (Morley, 1988 ). Hayward and Boeker ( 1998 ) find that analysts in an investment bank whose corporate finance arm is involved in the deal tend to make positive pronouncements about the deal even when other analyst groups (outside the investment bank) hold a negative view of the deal. This implicit conflict of interest has led to pressure from regulators to create a wall of separation between investment banking deal-making and analyst research (Galanti, 2006 ).

Sources of Multiple Agency Conflict in the Mergers and Acquisitions Context

While the multiple agency conflict in the IPO setting is easily apparent, the same is not always true in an M&A setting. In the IPO setting, the underwriter's institutional investors benefit at the expense of the IPO firm. However, in the M&A setting, one party does not always benefit at the expense of another. Moreover, the multiple agency conflict is much more nuanced and therefore muted. We believe there are at least four situations in this context where multiple agency conflict can arise.

The first situation where a multiple agency conflict can occur is in a “merger of equals.” Over the past 20 years, there have been several noteworthy deals that have been termed mergers of equals, including Travelers Group and Citicorp, GlaxoWellcome and SmithKline Beecham, and Viacom and CBS (Wulf, 2004 ). In this situation, both companies cease to exist independently, and existing stock in each company is surrendered for new stock in the merged company. What distinguishes a merger of equals from a regular merger (or acquisition) is that the target CEO and board are given shared power in the new organization as part of the merger agreement. Although this can be seen as a way to enhance post-merger integration, there are some troubling aspects of mergers of equals which point to a multiple agency problem. The actors who may be influenced by multiple agency conflict in this situation include the target company CEO, the target company board of directors, and the offering company CEO. The CEO of the target firm maintains an agency with the target firm, but his or her interests may become aligned with the offering firm given the CEO's future agency with that organization. While a CEO would normally want to bargain for higher valuation of his or her targeted company, the CEO who is able to maintain employment in the merged organization would have little incentive to try to squeeze more value from the offering firm (particularly if there were potential hostile takeover threats which would lead to a loss of employment if the merger of equals fell through). Wulf ( 2004 ) found that CEOs in mergers of equals freely traded higher valuation for power in the merged organization. Additionally, board members from the target companies in mergers of equals tended to maintain a higher proportion of the board seats in the merged company relative to a control sample of mergers. In this instance, the target CEO and the target board of directors tend to find that their interests more forcefully align with the acquiring firm. Not only do they have a future agency with shareholders from the acquiring firm, but their relationship with the acquiring firm transcends the focal merger and their investment horizon is longer (compared to those CEOs and board members whose employment ceases in a regular merger).

The acquiring CEO is benefited by a merger of equals for two reasons. First, the merger of equals typically results in positive returns at the announcement of the merger, but the target company's stock does not go up as much. As a result, the value of the merger is not typically captured as fully by the target company shareholders as would occur in a regular merger. Second, the acquiring CEO's compensation is likely to increase regardless of how well the merger performs in the future (Haleblian et al., 2009 ). Thus, in the short term, the acquiring CEO's reputation is often enhanced by the valuation effects and this may give the CEO additional power to pursue future mergers and personal gain through empire building (Amihud and Lev, 1981 ).

The second situation where a multiple agency conflict can occur in the M&A context is one to which we alluded earlier. When an organization becomes an acquisition target, certain governance provisions—such as fair price provisions (Sundaramurthy and Rechner, 1997 )—become very salient. When a fair price provision has been adopted by the board of directors, it mandates that all shareholders should receive the same price for their shares of stock should a tender offer be made. Without a fair price provision, the acquirer can tender a share offer to those shareholders who are willing to sell immediately at the tendered price. If shareholders in the targeted firm maintain their solidarity, they can resist the initial terms in order to obtain a higher offer (after ongoing haggling). When the acquisition process is drawn out, there may be additional suitors who join the acquisition fray, extending a competing offer, and so there is a strong incentive on the part of an acquirer not to let the negotiations get drawn out (Turk, 1992 ). The problem here is that the situation creates a sort of prisoner's dilemma for target firm shareholders. If some decide to hold out for a better offer, other shareholders can sell out, thereby giving the acquirer sufficient control to enact controlling interest. Afterward, the acquirer can complete the acquisition but offer those other shareholders a lower price for their shares of stock. So a key question here is which shareholders would want to sell out quickly. Research tends to indicate that institutional investment managers might be willing to jump at an early tender offer for a quick gain. For example, since institutional investors typically maintain large blocks of shares in any company, they provide strong oversight and have a strong incentive to monitor managerial actions that individual shareholders may lack; they will also have information quickly and will be first to act on the information. Furthermore, Sundaramurthy and Rechner ( 1997 ) found that organizations with higher institutional holdings are less likely to adopt a fair price provision, implying that institutional investors are the ones who would adopt a short-term investment horizon if the firm were targeted for acquisition. More recent research would tend to point to mutual fund managers (as opposed to pension fund managers) as ones who would maintain a short investment horizon (Hoskisson et al., 2002 ). Since mutual fund managers are pressured by their investors to show returns each year, they have an incentive to focus on short-term returns. While this pattern of investing results in an emphasis on acquiring innovation rather than developing it internally over a long period of time (for example), we believe it also impacts how much value is ultimately captured by target shareholders in an acquisition. In short, the multiple agency conflict where mutual fund managers have a shorter investment horizon may reduce the total value that targeted shareholders will ultimately obtain.

The third situation where a multiple agency conflict may arise concerns the aligning of interests among investment bankers in the M&A deal process. Kesner et al. ( 1994 ) identify the potential agency problem in M&A deals between the investment bankers and their clients who are acquiring another firm. Since investment bankers are paid as a percentage of the size of the deal and because they are largely compensated only when the deal closes (McGlaughlin, 1990 ), they have an incentive to see the acquiring firm pay a higher premium for the target firm. This is true not only for the investment bankers who represent the acquiring firm but also for the investment bankers representing the target firm. For the target firm, it will not have an agency problem with its representative investment bank; their goals are aligned because they both want to see the highest valuation possible since both will benefit from this. However, the acquiring firm wants to pay less for the acquisition. So, in any M&A deal, the interests of the target firm, its investment bankers, and the acquiring firm's investment bankers all align and are contrary to the interests of the acquiring firm. Indeed, Porrini ( 2006 ) finds that acquisition premiums are higher when acquirers use investment bankers than when they do not.

Multiple agency conflict may also arise in the M&A context when investment banks repeatedly work on opposite sides of deals. In other words, when an investment bank represents an acquiring firm and another investment bank represents a target firm, they begin to develop a relationship over the focal deal. Given the relatively small size of the investment banking industry and its geographic clustering, there is a distinct opportunity for investment banking firms to develop longer-term relationships among themselves. Given that their interests already align in any single deal, a longer-term relationship would create multiple agency conflict. Because they would have an agency in multiple future deals, they could begin to work together to minimize haggling in any single deal and to maximize the premiums while simultaneously reducing the amount of time it takes to complete any single deal. We have not seen any empirical work examining this potential situation. However, certain outcomes would occur if this is indeed occurring. For example, we should expect to see higher premiums paid the more that investment banks have worked together (on prior deals). Additionally, we should expect to see the time to complete a deal decrease as investment banks have worked together more. Whether this multiple agency conflict exists and whether reputational effects can mitigate this conflict remain to be seen. In sum, dual identities, transcending relationships, and differing investment time horizons can create significant problems in the context of mergers and acquisitions. We now consider joint venture situations.

Multiple Agency Theory in the Joint Venture Context

The joint venture is a special form of strategic alliance wherein two or more organizations contribute equity to form a new entity (Hennart, 1988 ). Strategic alliances and joint ventures remain popular organizational forms in the US and abroad (Ernst and Halevy, 2004 ;Meschi, 2005 ). The benefit of a joint venture is that it is a hybrid form between the extremes of the market and hierarchy and so it retains greater flexibility for joint venture partners, while still providing governance devices to minimize contracting hazards (Kogut, 1988 ). More specifically, equity ownership by the parent organizations provides a bond to ensure that each parent is jointly tied to the outcomes of the relationship (Williamson, 1996 ). This allows for the joint venture parties to share knowledge and resources and risk in a manner that would be less likely in a looser organizational form (Luo, 2007 ).

While a joint venture seems to provide several benefits in creating a relationship that allows for efficient contracting between or among parties, the failure rate for joint ventures is quite high, potentially up to 70 percent (Bleeke and Ernst, 1991 ; Johnson et al., 2002 ). Failure is often caused by partner incompatibility, management problems, poor HR practices (Schuler and Tarique, 2005 ), changing parent strategy, and even opportunism—particularly when environmental uncertainty is higher, as often occurs in an international setting (Reuer and Ariño, 2002 ;Ariño and Reuer, 2004 ; Luo, 2007 ).

Sources of Multiple Agency Conflict in the Joint Venture Context

While several causes for joint venture failure have been identified, multiple agency theory seems particularly salient in this context (Child and Rodrigues, 2003 ). In the joint venture, the parent firms represent principals to the joint venture. Managers who are employed in the joint venture are agents to the joint venture but also agents in their respective parent organizations. As such, the managers face issues of dual identity (Pratt and Foreman, 2000 ). This problem of dual identity and the concomitant problems that it creates is also evident in multinational corporations (MNCs), where a local senior executive identifies with a local staff but must also represent the non-local organization headquarters among the local staff (Zhang et al., 2006 ). Ring and Van de Ven ( 1994 ) make an interesting point about all interorganizational relationships in that the individuals representing their organization may develop trust in their personal relationships, but may be unable to do so when acting as an agent for their respective organization. So this dual identity can lead to problems for the agent in deciding whether to favor the parent organization or the local organization.

Because joint ventures tend to have a relatively short life cycle (Kogut, 1991 ), and because they can have a relatively high rate of entry and exit among partner firms (Meschi, 2005 ), the investment horizon of partners in the joint venture may differ. So the joint venture context produces two elements or sources of conflict that are associated with potential multiple agency conflict—dual identities among actors and potentially differing investment time horizons. The third element that underlies potential multiple agency conflict is the existence of transcending relationships among some of the actors in the context.

From a multiple agency perspective, we think that the third source of conflict is the most interesting and least researched to date. There has been recent research on alliances and networks which has examined past and concurrent relationships and how they affect alliance activity, but none that we know of examining transcending relationships among two or more actors if a relationship they collectively held with a different actor ceases. For example, Greve et al. ( 2010 ) found that higher relational embeddedness in the form of prior alliance ties was associated with lower withdrawal rates from an alliance. On the other hand, contrary to their expectations, they found that higher structural embeddedness, defined as third-party ties among actors, increased withdrawal rates from an alliance. So, on the one hand, trust (as evidenced by stronger previous ties) reduces withdrawal rates from an alliance. However, third-party ties present an interesting competitor tie that may motivate a conflict of interest (or possibly a co-alignment of interests among a subgroup of actors) and lead to withdrawal from a focal alliance. It would be interesting to examine from a multiple agency perspective whether withdrawal from one joint venture or alliance by two parties was associated with a new, separate joint venture between the two parties. Also, it would be interesting to examine how prior rivalries affect joint ventures and alliances; perhaps partners would more likely ally with their rival's former partners than direct rivals to the focal firm.

In addition to this recent research on alliances, Lavie et al. ( 2007 ) found that, when a firm in one alliance was also involved in competing multipartner alliances, it enjoyed greater benefits such as higher productivity and market success. This is an intriguing finding in light of multiple agency theory, because the focal partner with the transcending relationship (among other alliance partners outside the focal alliance) has an incentive to favor either the focal alliance or the other (non-focal) alliance. We think this situation could provide an interesting extension to examining how technology and technological capabilities evolve among the different parties. For example, if the focal alliance firm began to favor one alliance at the expense of another, we should expect to see one alliance developing new technology or new products faster than the other. As such, multiple agency theory may present extensions to alliance competitive dynamics as well.

Multiple Agency Theory in the Leveraged Buyout Context

Private equity or leveraged buyout (PE-LBO) firms are a relatively new form of financial institution which generally makes acquisitions by substituting public equity for private debt. Acharya et al. ( 2007 ) suggest PE-LBO firms emerged in the late 1970s and early 1980s, growing rapidly until 1990. After a contraction in the economy, they again grew rapidly and much larger through 2007 (see Chapter 24 of this volume for further discussion). The latter period of private equity grew dramatically primarily because obtaining capital from the debt market was relatively cheap. Interestingly, research suggests that, net of fees, these firms produce results that are slightly less than the S&P 500 (Kaplan and Schoar, 2005 ). Management fees of PE-LBO firms for those investing in funds to pursue private equity investments cost 2 percent of the uncommitted capital (about 4% of average invested capital) and 20 percent of the profits. Additionally, compensation for the top managers of PE-LBO firms is very high relative to publicly listed companies.

To illustrate how PE-LBO firms traditionally operate, the first step is to solicit and accept investment funds from banks, pension funds, sovereign wealth funds, hedge funds, endowments, and wealthy individuals. These individual PE-LBO firms, or syndicates of such firms acting together, use primarily borrowed money to buy publicly traded companies and then take them private. As such, these companies are taken off publicly traded stock exchanges for a period of time, one to four years on average. Typically, these PE-LBO firms increase the debt of the acquired company by five to eight times its prior debt level as a listed company. The new debt, borrowed primarily from banks, is securitized and then resold to hedge funds, pension funds, mutual funds, insurance companies, and other investors. This puts banks into the non-traditional role of reselling long-term debt and making most of their money from short-term fees and commissions rather than from holding the loans as long-term assets. Much of the acquired PE-LBO portfolio firm's new debt can be conceptualized as being used to pay dividends to the PE-LBO firms themselves. Once restructured, the acquired company is often resold in the public equity market. Many times PE-LBO firms combine acquired firms to build economies of scale or scope. Once the firm goes public again, the newly publicly traded firm has to repay the new, much larger, and more expensive debt principal and interest, or roll over and refinance the new debt to even newer debt (Guerrera and Politi, 2006 ).

Sources of Multiple Agency Conflict in the Leveraged Buyout Context

This arrangement leads to a number of potential conflicts. First, managers of the companies going private are able to take large amounts of money with them because of change-of-control provisions and the immediate vesting of options and restricted stock. This opportunity, in actuality, may make the managers of publicly traded firms more short-term oriented because it triggers increased short-term payouts for them if they go private. It also may make bankers more short-term oriented in that they focus less on the long-term ability of the firm to pay back its debts, since much of the risk for these has been moved off the banks’ balance sheets. Such financial institutions may now earn more money from short-term commissions and fees for advising, arranging the financing, and trading the new types of highly leveraged financial transactions and financially engineered deals than they could from returns on long-term bank debt or bonds. In regard to multiple agency theory, managers associated with going-private deals have dual identities (to their former shareholders and to the new PE firm), and in the transition they become more short-term oriented. Likewise, bankers may become less focused on the PE portfolio firm's viability (due to fees and debt securitization) and more focused on the relationship with the PE firm itself from which it derives significant fees.

Another conflict exists between the PE-LBO firm and bondholders. Because the debt of acquired PE-LBO companies increases five to eight times in order to pay dividends (to PE-LBO firms) and help restructure the acquired companies, the debt owned by older bondholders is considered more risky, and the price often falls by about 15 percent. When the old bondholders made their investment, they did not perceive the significant additional borrowing that would take place (Cass, 2007 ). Thus, the new principal of the firm makes it more difficult for prior contracts with capital providers to be fulfilled.

Besides old debtholders, a leveraged buyout may also not be in the interest of long-term shareholders because current managers have an incentive to sell the firm owing to often increased salaries and bonuses associated with such a transaction, where staying on not only as managers but also as manager-investors leads to increased potential wealth. Under the new ownership arrangement, so much money is taken out of the system to pay fees and dividends to the new owners that managers will often not have enough capital to make long-term investments. As PE-LBO deals foster restructuring, this also puts downward pressure on worker wages and benefits. Job growth and decline appear to be directly related to the difficulty of paying back the highly leveraged amounts of debt (Ulrich and Brockbank, 2005 ). Again, the PE investment makes it difficult to fulfill the dual identity of firm managers who are becoming agents to the PE firms and also historical agents to firm employees who desire to retain their wages and employment.

Multiple Agency Theory in the Bankruptcy Context

While not as often studied as other governance events such as IPOs or acquisitions, bankruptcy presents an intriguing case for those interested in studying agency conflicts (Daily, Dalton, et al., 2003 ). The typical firm declaring bankruptcy has experienced a sharp reversal of fortune after earlier successes, leading to a situation of cash-flow inadequacy in which the firm is unable to pay its bills as they become due. As firms enter bankruptcy, they face a momentous change in purpose: once bankrupt, the firm must be managed primarily for the good of its creditors, rather than its shareholders (D’Aveni, 1990 ; Cieri et al., 1994 ). This can be quite difficult for managers who are accustomed to managing the firm primarily for the benefit of shareholders and whose equity holdings and stock options continue to tie their financial interests closely to the interests of shareholders (White et al., 2011 ). In the midst of this, managers are frequently turning over, old sets of shareholders are being exchanged for new ones, and a variety of actors possess incentives which do not bode well for the future health of the bankrupt firm.

In the US, 1 bankruptcy does not necessarily signify the end of a firm. Most large corporate debtors file for bankruptcy under Chapter 11 of US Code Title 11. So-called “Chapter 11” filings are designed to allow firms to reorganize their debts and then exit bankruptcy as a newly viable enterprise. Filing under Chapter 11 provides firms with three significant privileges. First, firms are protected from the immediate collection efforts of their creditors. This allows them to keep assets pledged as collateral and to shelter much-needed cash in hand. Second, firms are able to continue operating while in bankruptcy. This provides them with the ability to maintain many customers, continue business development efforts, and work toward necessary changes in their business processes. Finally, firms in Chapter 11 are able, with the approval of the court, to renegotiate or renege on certain contracts in an effort to streamline their cost structure so that they can be more competitive in the future. In some locations (e.g. Sweden), management is automatically replaced when a firm files for bankruptcy protection (Thorburn, 2000 ). However, in the US, bankruptcy court judges typically allow firm executives to continue to manage the firm through the period of insolvency.

During bankruptcy, which can vary from a few months to several years, firms negotiate with creditors and other business partners to restructure their debts in such a way that the firm may once again have a viable business model. As part of this, top managers draw up a bankruptcy reorganization plan that is submitted to the bankruptcy judge. Firm creditors and residual claimants are divided into seniority classes (e.g. secured bondholders, other secured creditors, unsecured creditors, preferred shareholders, common shareholders). Creditors whose rights are affected by the reorganization plan then have the opportunity to vote by class on the plan. On the basis of an affirmative vote, the judge can confirm the plan and allow the firm to exit bankruptcy.

Key to US bankruptcy law is a provision that creditors must generally be paid off completely before shareholders are able to retain any value in the firm. Since bankrupt firms typically do not have the needed assets to satisfy all of their debts, Chapter 11 reorganizations usually result in pre-bankruptcy shareholders losing their firm equity holdings. All old shares of stock are canceled, and new stock is issued to creditors whose debts could not be completely paid by the firm. This reapportioning of firm assets and equity creates a unique level of potential conflict among the different classes of creditors and the pre-bankruptcy shareholders. In effect, it creates a complex and high stakes endgame scenario which pits the various firm claimants against each other for control of the firm, post-bankruptcy. In such a setting, issues related to multiple agency theory are seen in clear contrast.

Sources of Multiple Agency Conflict in the Bankruptcy Setting

When examining bankruptcy from the multiple agency perspective, we must pay careful attention to the key actors in the bankruptcy process. These include the firm's senior executives, specialized bankruptcy lawyers, and firm creditors. Other important participants in the bankruptcy process who won’t be fully considered here include the bankruptcy judge and the firm's shareholders.

Throughout this chapter, we have highlighted the fact that dual identities, transcending relationships, and differences in investment horizons tend to engender multiple agency problems in many governance contexts. We find the same to be true in the situation of bankruptcy. As noted above, under US bankruptcy law, firm executives owe their fiduciary obligations primarily to firm creditors but must act under a governance structure that can still incentivize them to seek the best interests of shareholders. Facing this dual identity situation—one identity new and foreign (yet legally mandated) versus another that has been long ingrained in their attitudes and behaviors—leads to difficult conflicts for the managers. Take, for instance, the issue of the firm's reorganization plan. As noted earlier, this plan specifies which firm claimants will receive what type of payment and which other claimants will be left empty-handed. When assembling the reorganization plan, both the potential transcendence of employment relationships beyond bankruptcy and looming time horizon issues will weigh on managerial decisions. If firm executives do not expect to be retained by the new owners of the firm post-bankruptcy, they may do their best to favor influential owners or investors who may be able to help shepherd them into a position in another firm. On the other hand, if they anticipate the possibility of remaining with the firm post-bankruptcy, they will be strongly incentivized to ingratiate themselves with the class of current creditors who will become the firm's new owners upon exit of the firm from bankruptcy (LoPucki and Whitford, 1993 ). Thus, dual identities, transcending relationships, and differences in investment time horizons may strongly influence the behavior of firm managers in bankruptcy situations.

A second group that plays an important role in the bankruptcy process is the specialized lawyers that aid firms in navigating the bankruptcy process. Because these experts are familiar with court procedure and legal regulations and norms, their assistance is invaluable to the firm. However, they are expensive to maintain. In some cases, professional services fees related to bankruptcy can dissipate a significant proportion of the value of a firm. And while the lawyers that provide these services have a vital role as agents to the firm, their service is compromised by the outside relationships that they maintain with each other. In studying the relations between these bankruptcy lawyers, LoPucki and Whitford ( 1990 : 156) observed the following:

The [lawyers] who negotiated reorganization plans were not only representatives of the parties in interest, but also members of professions, of independent firms, and of the bankruptcy community …[T]he lawyers in the cases we studied had an incentive to be concerned not only with the welfare of their clients but also with their relationships to each other.

When lawyers broke industry norms by advocating too aggressively for their clients, their reputations suffered, and they might find it more difficult to obtain business in the future (LoPucki and Whitford, 1990 ). Thus, the dual identity of the lawyers (as agents to the firm but also as members of a professional community) and their transcending relationships with others in the legal field compromised their ability to fully advocate on behalf of the bankrupt firm. This type of thinking was driven by an eye toward maintaining a strong flow of legal clients over a time horizon that extended well past the anticipated end of the relationship with the firm they were hired to serve. Like the firm's managers, the legal specialists serving the firm during bankruptcy are likely compromised by multiple agency conflicts.

Finally, firm creditors are key resource providers for the firm. These creditors include firms providing “debtor-in-possession financing,” allowing firms to access the capital needed to continue operations while in bankruptcy, banks providing lines of credit, and corporate bondholders. While conventional creditors, such as banks, would prefer to have cash in hand rather than shares of stock in a firm emerging from bankruptcy, other entities that sometimes act as creditors—such as hedge funds and private equity funds—may see the bankruptcy process as an inexpensive way of gaining control over the firm. Employing what's known as a “loan to own” strategy, such funds either loan the bankrupt firm money directly or they buy up deeply discounted firm debt. Then, when it appears the struggling company may not be able to fulfill all its debt obligations, the private equity fund pushes the firm into bankruptcy. Because creditors often receive equity in the restructured firm in exchange for cancellation of firm debt, this strategy can enable these entities to gain controlling ownership of the firm at a sizeable discount.

Such transactions are viewed by many participants, particularly other creditors, as not showing good faith, but they are structured in such a way that they typically do not run afoul of legal requirements (Robertson and Cicarella, 2008 ). Cases such as this are clearly not motivated by any sense of duty to the struggling firm. Rather, hedge fund and private equity fund managers seeking to lead firms into bankruptcy are focused on maximizing returns for their fund investors. The identity most salient to hedge and private equity funds in these situations is not that of capital provider but of investment manager. Whereas the managers of the soon-to-be bankrupt firm hope for longer-term capital access, the hedge and private equity funds (much as the VC firms during IPO) seek to move as quickly as possible toward exit. Thus, dual identity, transcending relationships, and differences in investment horizons can conspire together to turn the capital provider from friend to foe.

Traditional agency models investigate one-to-one relationships between principal and agent (Arthurs et al., 2008 ). In these models, singular identities of actors as principal to one agent or agent to one principal, a lack of outside business or social relationships, and a weak sense of temporality can sometimes limit theorizing. In contrast, multiple agency theory loosens these key restrictions. First, multiple agency theory examines the dual identities of contracting parties. Some principals have multiple agents, some agents serve multiple principals, and some entities are principal and agent simultaneously. Second, many contracting parties have transcending relationships—outside their focal principal–agent relationship—that significantly influence their behavior as principal or agent. Finally, when the relationship among some actors transcends the focal situation, these relationships can lead to differing investment time horizons which can interfere with appropriate incentives.

To explore multiple agency theory more fully, in this chapter we’ve applied the theory to a variety of important corporate governance contexts. As the sections above illustrate, there are increasing opportunities for conflict in agency settings, not only between traditional principals and agents but also among agent-owners representing ultimate principals and other influential business partners and governance participants. Interestingly, multiple agency theory may even suggest role reversals vis-à-vis traditional agency theory expectations (e.g. managerial agents working to protect shareholders’ wealth from short-term owner-agents). Below we elaborate more fully on the theoretical ramifications and contributions of multiple agency theory in each of the settings highlighted earlier: IPOs, mergers and acquisitions, joint ventures, leveraged buyouts, and bankruptcy.

Ramifications for Multiple Agency Conflicts

The initial public offering context.

Earlier, we showed how multiple agency conflict can lead to higher underpricing in the IPO process. An important point to make regarding multiple agency conflict in this setting is that viewing the situation from a traditional agency perspective would provide not only inconsistent pronouncements but would also underestimate the potential agency problem. For example, from a traditional agency perspective, one would assume that VCs, as experienced principals, would provide superior monitoring of the underwriter and that insiders (who are often seen as the “source” of an agency problem) may lack the motivation to provide sufficient oversight. As it turns out, the opposite appears to be the case in that insiders have unified goals based on their agency (and concomitant employment) and longer investment horizon, whereas VCs’ motivation to monitor is undermined by their outside agency, transcending relationship with the underwriter, and shorter investment horizon. Research shows that insiders on the board of IPO firms serve to improve governance and reduce underpricing, and thus increase money available for the new venture IPO firm (Arthurs et al., 2008 ). Additional research using a multiple agency approach shows, however, that, if VCs stay on as principal after the IPO, they can counter the trend of founder-centric firms who tend to avoid contingent compensation (Allcock and Filatotchev, 2010 ).

The agency problem between the underwriter and the issuing firm faces severe goal incongruence problems which are not easily overcome. Specifically, the underwriter's agency beyond the focal IPO creates an additional motivation to please its other principals (institutional investors) at the expense of the IPO firm. In this situation, it seems unlikely that typical agency mechanisms will be very effectual. In other words, the IPO firm must increase the level of monitoring and use of incentives and bonding to overcome the stronger incentives the underwriter has to favor its other principals. One solution to the underpricing problem is to make sure that firms do not just take the price offered by investment banks and leave too much money on the table. Insiders on the board need to take their governance role seriously. Another potential multiple agency context is found in mergers and acquisitions.

The Mergers and Acquisitions Context

While the multiple agency conflict in the M&A context is more nuanced, the ramifications are that some parties can work together in ways to take advantage of other parties in the process. For example, in the case of mergers of equals, shareholders of target firms are left with lower premiums for their shares of stock, while the target CEO and board of directors maintain (at least partial) post-merger employment. There seems to be little recourse for these shareholders except to exit their investment. After all, it would seem that the board of directors is being subverted in the process. It would be interesting to identify whether the relational and reputational capital of board members can have an impact on the likelihood that a merger of equals occurs. Those board members who maintain multiple directorships would have less incentive to agree to a merger of equals (to preserve their board membership) if this meant lower valuation of the target firm. In the case of fair price provisions, shareholders would be wise to act quickly and sell out (accepting the original tender offer) if their company does not have a fair price provision. This is the dominant choice (defection) in a prisoner's dilemma game and fits appropriately in this context as well. Finally, it remains to be seen whether multiple agency conflict arises with investment bankers working increasingly together. If this truly occurs, then acquiring firms would have an incentive to identify an investment bank with no previous ties to the target firm's investment banks.

The Joint Venture Context

Unlike the M&A setting, the multiple agency conflict in the joint venture setting is straightforward. When a joint venture is only between two firms, the conflict arises out of the competing interests of the joint venture managers as well as competing interests between the two organizations putting up the capital. While issues of identity and loyalty to the joint venture are important and may influence how managers approach their relations with other managers in the joint venture, we find it unlikely that managers would actually favor the joint venture over their respective parent organization. Unless the managers’ employment was attached to the life of the joint venture, they would have no transcending relationship with the joint venture unless it were ultimately spun off or sold off to another organization. As such, their employment with their parent firm should provide an incentive for them to favor their parent organization. However, in an international setting, joint ventures are often funded with capital from local exchanges and may create diffusion of power around the world and make change difficult to accomplish. This has certainly been the case for Philips Electronics. Because of its decentralized structure with many joint ventures, management has found it difficult to restructure the firm to become more centralized (Bartlett, 2009 ).

Child and Rodrigues ( 2003 ) argue that, since partners in a joint venture contribute complementary tangible and intangible assets, they (in effect) become agents to one another. When a joint venture or strategic alliance includes more than two parties, additional sources of multiple agency conflict may arise. For example, two members in the joint venture can work together to take advantage of a third party. In this situation, it seems important for joint venture members to maintain additional safeguards beyond ownership in the joint venture. For example, it may be possible to create licensing agreements concerning any technology that is developed in the joint venture so that the rights to ownership create legal encumbrances for any technology that is developed in the future. In this way, each member of the joint venture could create a tool to prevent side dealing at the expense of any other joint venture member. This would also create incentives to maintain the joint venture because two parties establishing a transcending relationship would have less ability to profit together (without the third party also profiting).

The Leveraged Buyout Context

The ramifications of multiple agency conflicts have had important consequences for all parties involved in the private equity-LBO setting. One such implication is herd behavior when conditions are right for LBOs; this has led to periods of boom and bust not only for PE-LBO firms but also for the M&A market more generally. Because private equity firms invest for relatively short periods of time and banks gain short-term fees for facilitating buyouts, it appears that firm managers might be pushed toward short-term-oriented behaviors that result in underinvestment and losses to longer-term shareholders. This would suggest, for instance, that private equity deals would lead to lower R&D expenditures in the long term. There is research to suggest that this concern is, in fact, valid (Long and Ravenscraft, 1993 ). However, there are other perspectives that suggest that being released from the control system of a large firm hierarchy can release the separate private buyout firm to be much more entrepreneurial (Wright et al., 2000 ). This may also be true if better incentives are applied (Phan and Hill, 1995 ) and a new entrepreneurial mindset is developed (Wright et al., 2001 ; Moschieri, 2011 ). There may also be evidence that leveraged buyouts lead to lower wages and net loss in employment gains, although there is some argument with respect to this question (Sorkin, 2008 ).

The Bankruptcy Context

Over the past several decades, scholars have turned to traditional agency theory to provide insights into the bankruptcy process. Some have investigated the root cause of bankruptcy, suggesting that the act of bankruptcy may be reflective of conflicts between top executives of the firm and outside parties (Daily and Dalton, 1994 ) or that bankruptcy represents “the legal resolution of severe shareholder-creditor conflicts” (D’Aveni, 1989 : 1120). Others have drawn inferences from the outcome of bankruptcy back to the quality of managers (Daily, Dalton, et al., 2003 ). While these agency theory propositions are insightful, it's clear that they fail to fully capture the complexity inherent in a process in which there are “perplexing layers of agency” (LoPucki and Whitford, 1990 : 154), with multiple parties maintaining multiple relationships. While traditional agency theory does recognize that agents have their own priorities and preferences that can conflict with those of the principal, it does not make strong allowance for the possibility of outside loyalties, or dual identities, of agents that interfere with their ability to serve the principal. In the case of bankruptcy, we have seen how these transcending relationships can impact the ability of key players to fulfill their prescribed roles, particularly when differences in time horizon are present.

A second insight of multiple agency theory into the bankruptcy situation is an enhanced understanding of the difficulty of agents in meeting the simultaneous demands of multiple principals, particularly when these demands are sharply at odds, as they are during bankruptcy. While creditors and shareholders have largely overlapping interests during the normal course of business (both want higher earnings, the continued health and existence of the organization, etc.), during the endgame process of bankruptcy when their share of the assets of the firm is being measured out and ownership interests in the new firm are being set, the interests of the two groups sharply conflict (Asher et al., 2005 ). For instance, shareholders—who are typically underwater at the point of bankruptcy—have an interest in pushing managers to take extremely risky actions in the hope that a long-shot investment pays off big and the firm becomes solvent once more, allowing them to retain some value in their equity holdings (LoPucki, 2004 ). On the other hand, creditors want the firm to be extremely conservative in its decision-making while in bankruptcy so that the resource base of the firm (which could be used to pay their claims) is not squandered. As managers, it is very difficult to satisfy both of these groups simultaneously. Perhaps this is why the court is often involved to referee bankruptcy settings.

In the subsections that follow, we briefly address two other important issues—cooperation among agent-owners and the managerial processes associated with multiple agency theory—before offering concluding remarks.

Cooperation among Agent-Owners

We have focused the majority of this chapter on conflicts occurring between parties to the agency relationship. However, multiple agency theorizing may also elucidate increasing opportunities for cooperation between subsets of principals and agents. Research examining these complementarities might provide additional contributions to this line of research. For example, Hoskisson et al. ( 2009 ) suggest there might be complementarity between monitoring and bonding over time rather than a concurrent substitution effect in governance (Deutsch et al., 2011 ). Allcock and Filatotchev ( 2010 ) also demonstrate the possibility of complementarities in their examination of incentive effects among IPO firms.

Another area of study pertaining to cooperation among institutional investors is in formal organizations that institutional investors have used to manage issues pertaining to poor portfolio firm performance, such as executive compensation and shareholder rights issues. The Council of Institutional Investors is one such organization. Research, for example, by Ward et al. ( 2009 ), has shown the impact of such third-party advocacy. They found that institutional investors responded to negative third-party signals by reducing their holdings in a group of 93 firms placed on the Focus List of the Council of Institutional Investors. However, the negative repercussions were lessened if the firm signaled that it had a strong set of outside directors and demonstrated responsiveness, for instance, by increasing CEO incentives associated with performance.

As noted previously, another area where complementarities might be found is within a single agent-owner where the institutional investor can receive an advantage by owning both sides of a transaction, for instance, in acquisitions or joint ventures. If a single institutional investor owns both the acquiring and target firm in a potential acquisition, they may be able to manage the transaction in a way that will create value (Goranova et al., 2010 ). For instance, often the acquiring firm's stock price is reduced upon announcement, whereas the target firm usually increases in value due to the premium that must be paid in an acquisition. As such, if you are able to forecast which firms are more likely to pursue an acquisition in a particular industry, you may be able to sell short or use a put option to take advantage of such a potential transaction. Alternatively, you could go long on the stock by using a call option on the potential target firm to take advantage of the future rise in price. In this way, the single institutional investor can take advantage of potential transactions in the short term.

Managerial Processes to Deal with Multiple Agent-Owners

In order to manage the potentially complex interests of multiple agent-owners, managerial processes will necessarily be more complex as well. For example, if there is potential for conflicting requests by agent-owners, top-level managers will have to find ways to deal with these conflicting interests. There is some work in finance regarding getting the appropriate numbers of blockholders relative to managerial effectiveness to jointly optimize governance and managerial efforts (Edmans and Manso, 2011 ). This will likely raise, for example, the visibility of the investor relations department, which is often the first contact with large investors for publicly traded firms (cf. Bushee, 2004 ). Recent research by Westphal and Bednar ( 2008 ) suggests that managers of firms are able to participate in discussions with institutional investors in a way that reduces the need to make changes being sought by some agent-owners. Westphal and Bednar find that, through ingratiation, executive officers of large publicly traded firms are able to lessen the impact of intense activism. Similarly, Westphal and Graebner ( 2010 : 15) find that negative reports by financial analysts encourage firms to “increase externally visible dimensions of board independence without actually increasing board control [over] management” and additionally spur firms to pursue impression management strategies to improve the nature of analyst coverage. As such, it is likely that conflicts among agent-owners would increase the intensity with which firms seek to manage their relationships with owners. This may be accomplished, for example, by a focus on attracting the right investors through advertising and communication or more actively seeking to partner with certain types of owners (White, 2010 ).

Other Future Research Areas

In addition to the research ideas we have already highlighted in this chapter, we would like to conclude with a few additional thoughts on areas where multiple agency theory could be advanced or where it could offer significant theoretical contributions to the literature. Most importantly, development of formal theories in this area will be of significant importance. In this chapter we have suggested that dual identities, transcending outside relationships, and investment time horizon differences play important roles in the development of multiple agency conflicts. How do these factors determine the extent of such conflicts? Are their effects independent and additive, or are they perhaps multiplicative?

Additionally, the multiple agency perspective can allow us to examine agent-owners coming from different institutional contexts, such as diffused agent-owners coming from developed countries versus dominant agent-owners (for example, family owners) in emerging markets (Filatotchev et al., 2011 ). Outside board members, usually lumped together as independent outsiders focusing on more intensive monitoring for shareholders, might be seen as agents representing different interests, such as representatives of specific institutional blockholders (Deutsch et al., 2011 ), labor groups (e.g. in Germany boards often have labor or government representatives), or top professionals that have their own individual motives. As such, multiple agency theory as a perspective should allow us to examine more aspects of corporate governance than the traditional narrow incentive and monitoring notions of traditional agency theory.

Because multiple agency theory can house many important corporate strategy and governance concerns (as illustrated by the broad set of issues covered in this chapter), middle-range models focused on particular phenomenological settings may be especially pertinent to the literature. The work of Arthurs and colleagues ( 2008 ) in the IPO context gives an example of how this type of research could move forward profitably. Besides the contexts explored directly in our chapter (IPOs, mergers and acquisitions, joint ventures, leveraged buyouts, and bankruptcies), other settings that might be useful to cover would include family ownership in both developed and emerging economies (e.g. Breton-Miller et al., 2011 ), government ownership, and so-called sovereign wealth funds (Connelly, Hoskisson, et al., 2010 ). Despite our call for middle-range models, we emphasize that an overarching theoretical approach which would help bind the use of the perspective in particular empirical settings is also essential.

Finally, the breadth of the multiple agency perspective should allow us to cover less-addressed issues of principal opportunism (White and Hoskisson, 2012 ; Shleifer and Summers, 1988 ). While traditional agency theory has focused on agents as the opportunistic partners in contracting relationships, multiple agency theory makes clear that principals can likewise engage in guileful actions that are detrimental to the contracting relationship. This insight brings into question many of the hidden assumptions of traditional agency theory. For instance, traditional agency theory often presupposes that actions taken by managers to entrench their positions in the organization are likely to be associated with opportunistic behavior. However, if we admit the possibility that managers may need to defend the firm against opportunistic actions by principals (Dalziel et al., 2011 ), then such managerial efforts to hold and retain power may well be beneficial to the firm and its future performance rather than detrimental.

It is our hope that additional work in the emerging multiple agency perspective will open up new frontiers in our understanding of corporate governance. We look forward to gaining a greater understanding of the web of relationships that influence the incentives and actions of owners, managerial agents, and other important contracting parties.

In this section, we focus on bankruptcy in the United States. While bankruptcy procedures vary somewhat in other locations, many of the multiple agency issues we highlight are emblematic of the types of problems to be found in other nations.

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Corporate Governance: Agency and Stewardship Theories

Introduction, agency theory, stewardship theory, comparative analysis, personal reflections and conclusions, works cited, video voice-over.

Corporate governance stands for a system of internal laws, rules, and practices, which are used to control and govern the decisions made by the company’s employees and managers in the scope of day-to-day activity. Various forms of corporate governance existed long before the appearance of the definition and various theories, as well as before the development of management into an academic discipline. They are used to describe the relationships between shareholders, stakeholders, the government, the society, and other various internal and external forces surrounding a business organization. Due to the variety of factors influencing the company and the market, no single theory can be used to define and explain the phenomenon. The purpose of this paper is to compare and analyze two opposing theories of corporate governance, which are the Agency theory and the Stewardship theory.

Agency theory was proposed in 1972 by Alchian and Demsetz and further elaborated on in studies by Jensen and Meckling, four years later (Tricker 59). This theory is very extensive and covers various areas, such as accounting, marketing, economics, sociology, politics, corporate and organizational behaviors. This theory defines the relationship between different parties involved in corporate governance as a contract under which employees (or managers/directors) are obligated to perform services on behalf of company owners (principals) (Tricker 59). According to this theory, the principals elect their representatives and give them the responsibilities to act and protect their best interest in return for compensation.

Aligning the interests of owners and managers is one of the primary aspects of the agency theory. It operates on the assumption that the interests of principals and executives remain in the state of permanent conflict, which cannot be solved. In order to keep managers in line and prevent them from cheating out the shareholders, rigorous systems of control must be put in place (Madhani 11). All expenses associated with control are offset by the increase in quality and decrease in corporate theft.

Stewardship theory, in many ways, serves as an antithesis of Agency theory, as it emphasizes the ‘Theory Y’ of motivation (Madhani 14). This theory states that in a healthy corporate culture built on honesty, integrity, and trust, there needs not to be an emphasis on monitoring. This theory highlights the existence of healthy working relationships between managers and shareholders, which, in turn, helps minimize the costs of monitoring and controlling while increasing the speed of decision-making and the autonomy of managers and executives. According to the stewardship theory, managers and employees are trustworthy individuals, and as long as they are compensated according to their needs, there is little to no risk of them abusing their positions and causing harm to shareholders’ interests (Bosse and Phillips 277). Thus, stewardship theory advocates management empowerment and the active role of shareholders in their own companies.

The reason why Agency theory and Stewardship theory are so different lies in the initial assumptions behind them. Agency theory is based on the X theory of motivation, which assumes that the average worker or manager is lazy, has little interest in work, and works only to gain a sustainable income. Therefore, they require constant supervision and control in order to provide the bare minimum required by the organization. The Y theory of motivation, however, states that employees can be internally motivated to better themselves by utilizing non-material encouragement practices. Appreciation, status, and satisfaction from a job well done are what drives employees better than threats of punishment and intimidation.

When translated into the Agency theory, it becomes a justification for establishing monitoring mechanisms in order to eliminate the conflict of interest. The associated costs are dubbed “agency costs.” In addition, agency theory advocates for the use of outside forces to monitor the processes in a company, as outsiders are less likely to be involved in corruption. Stewardship theory, on the other hand, advocates for the appointment of executive directors from inside the company, stating that a manager that rose up through the corporate ladder is likely to know the company from the inside out and make decisions based on internal knowledge of the situation and personal experience.

Personally, I feel that the Stewardship theory is closer to my own set of values and beliefs than the agency system. It is because I view myself as an honest person that can be entrusted to do my duty without anyone looking over my shoulder. However, I recognize that both of these theories have some truth to them. Stewardship theory is more in line with modern leadership theories, such as transitional leadership or servant leadership, which are used to cultivate trust and personal growth in managers and employees alike.

At the same time, some of the recent scandals regarding corporate theft and managerial fraud in large companies, such as Microsoft, Google, Walmart, and others, show that the idea of control at the highest levels of performance is not an idea to be discarded (Keay 1293). It is possible to introduce agency-based mechanisms in a predominantly stewardship-based organization (Tilema 153). In China, Agency theory is very popular due to the repetitiveness of work, low pay, and poor conditions (Jinghan 26).

Controlling mechanisms are required, as without them the quality of products will inevitably fall. My conclusion mirrors the statement made at the beginning of the paper, that a single theory is not enough to describe the realities of corporate governance. Both theories have their strengths as well as weaknesses and should be used in accordance with the situation.

Bosse, Douglas A., and Robert A. Phillips. “Agency Theory and Bounded Self-Interest.” Academy of Management Review, vol. 42, no. 2, 2016, pp. 276-297.

Jinghan, Chen. A Primer on Corporate Governance: China. Business Expert Press, 2015.

Keay, Andrew. “Stewardship Theory: Is Board Accountability Necessary?” International Journal of Law and Management, vol. 59, no. 6, 2017, pp. 1292-1314.

Madhani, Pankaj M. “Diverse Roles of Corporate Board: A Review of Various Corporate Governance Theories.” IUP Journal of Corporate Governance, vol. 16, no. 2, 2017, pp. 7-28.

Tilema, Sandra. “Does an Agency-Type of Audit Model Fit a Stewardship Context? Evidence from Performance Auditing in Dutch Municipalities.” Financial Accountability and Management, vol. 32, no. 2, 2016, pp. 135-156.

Tricker, Bob. Corporate Governance: Principles, Policies, and Practices. 3rd ed., Oxford, 2015.

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