Agency Theory and Executive Copensation

Agency Theory and Executive Compensation


Agency theory essentially involves the costs of resolving conflicts between the principals and agents and aligning interests of the two groups. In this case, agency theory focuses on the on the link between executive compensation and firm performance. Executive compensation can be used to create shareholder value by improvement of a firm’s performance. Management’s role as an agency and their relationship with shareholders often results in a conflict of interest in the area of executive compensation. While management is focused on developing the company through its qualified CEOs, shareholders are interested only in their returns. As a result, differing interests may exist where investment cash flows, financial management and reporting are concerned. These mechanisms are considered to be the lifeblood of an organization yet have often been subjected to agency issues.
Agency costs refer to the reductions in benefits to ow...