Agency theory

Agency theory relative to corporate governance assumes a two-tier form of firm control: managers and owners. Agency theory holds that there will be some friction and mistrust between these two groups. The basic structure of the corporation, therefore, is the web of contractual relations among different interest groups with a stake in the company. In general, there are three sets of interest groups within the firm. Managers, stockholders and creditors (such as banks). Stockholders often have conflicts with both banks and managers, since their general priorities are different. Managers seek quick profits that increase their own wealth, power and reputation, while shareholders are more interested in slow and steady growth over time. The purpose of agency theory is to identify points of conflict among corporate interest groups. Banks want to reduce risk while shareholders want to reasonably maximize profits. Managers are even more risky with profit maximization, since their own careers are based on the ability to turn profits to then show the board. The fact that modern corporations are based on these relations creates costs in that each group is trying to control the others. The agency model of corporate governance holds that firms are basically units of conflict rather than unitary, profit-seeking machines. This conflict is not aberrant but built directly into the structure of modern corporations.
Corporate governance broadly refers to the mechanisms, processes and relations by which corporations are controlled and directed. Governance structures identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and includes the rules and procedures for making decisions in corporate affairs. Corporate governance includes the processes through which corporations' objectives are set and pursued in the context