Question

Describe agency theory and provide an example

Answer 1

Agency theory suggests that problems arises due to conflict of interest between promoters of company or stockholders  and the management. It is also called the conflict of interest between the principal and the agenst. The conflict arises due to interest of stockholder to maximize their own wealth whereas interest of manager will be to increase their own wealth.
This principal and agent conflict can be minimised by using contracts and laws . This would make the agents legally committed to the stockholders. Performance linked pay would motivate agents to work in sync with the owners and reduce agency problem.

Examples are investor and mutual fund mangers. Investors are the principal and the mutual fund managers are the agents.Investors might want more return while mutual fund managers want more commission or more fees.