Agency Theory and its contribution to current accounting practices Essay

The purpose of this study is to develop a relationship between bureau theory and the bing patterns of accounting. In the study, the job of agent-principal will be described with the chief effects for business-related relationship. After placing the job, the accounting patterns will be linked to the issues addressed in theoretical account that will be explained. The study will look at a instance survey related to bureau theories and its affects within accounting patterns. Finally it will demo the ways the accounting patterns meet the jobs raised by the agent-principal relationships.The bureau theory is a mixture of the relationships between principals and agents, it occurs when chief and the agents create a deputation ( Donaldson, L. & A ; Davis, J.

H. , June 1991 ) . Berle and Means 1932 stated that the Agency theory argues that in modern corporation, where portion ownership is widely held, managerial actions depart from those required to maximize the stockholders return, this was besides backed up by Pratt and Zeckhauser in 1985. Harmonizing to Jensen and Meckling, 1976, In Agency theory footings, the proprietors are principals and the directors are agents and there is an Agency loss which is the extent to which returns to the residuary claimants, the proprietors, autumn below what they would be if the principals, and the proprietors, exercised direct control of the corporation ( Donaldson, L. & A ; Davis, J.

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H. , June 1991 ) .The long term schemes for bureau theory include the rule of company, concern, franchise, etc supplying inducements such as increasing committee, go oning to supply advertisement, preparation and motive to increase mercantile establishment operations. To reason this Carney and Gedajlovic stated that sing of the exogenic factor, mercantile establishment directors have an inducement to fiddle and belie their abilities because the house is difficult to distinguish the director ‘s public presentation behaviour ( Mathieu, 1997 ) , While the short-run schemes include equilibrating supply with demand at the shortest bend around clip.

Agency theory tends to impact concern determinations by concentrating on set uping inducements as mentioned in the long-run schemes above. However, it may be really dearly-won and may make moral jeopardies if top direction attempts to over maximise net incomes for themselves alternatively of for the employees. The cost to pull off and supervise minutess can impact both the domestic and planetary fiscal directors due to the scheme going really expensive ; however this scheme can hold the negative impact upon the administrations endurance.

Conflicts of bureau theory

There is a struggle between principals and agents ( stockholders and directors ) that can potentially hold a annihilating concern effect. The cost of supervising attempts, mensurating consequences and chances lost can be significant. Incentives and deterrences may non ensue in wanted result, when concerns should scan their environment invariably to seek chances to run into the involvement of their ain stakeholders. Agency theory is a little entity of fiscal economic sciences that looks at struggles of involvement between people that have different involvements for the same assets, this means that their will ever be changeless struggles between: stockholders & A ; directors and stockholders & A ; bond holders. These are the ground why administrations make changeless acquisitions that tend to be bad for the stockholder, why exchangeable bonds are sooner used while normal bonds are frequently sold with warrants and eventually shows the importance of capital constructions.

Harmonizing to Eisenhardt ( 1989a ) , bureau theory is devoted to the solution of two jobs that can originate from bureau relationships. The first job is end related and arises when: I ) there is a struggle between the ends of the principal and the agent ; and ii ) the confirmation of the agent ‘s behavior is hard or expensive to be verified by the principal. The 2nd job is risk-related.

If the agent and the principal have different attitudes towards hazard, it is likely that both will act otherwise and in conformity to their hazard penchants.Identifying conflicting places between any two agents and explicating the administration mechanisms underlying these relationships ( that limit the agents ‘ behavior ) is known as the Positivist bureau theory ( Eisenhardt, 1989a ) . A different place is found in the principal-agent research ( as opposed to the positive bureau theory ) and relies on a more mathematical and abstract attack to the job. Although in different positions, these two attacks can be complementary as it can be seen in the citation below ( Eisenhardt, 1998a: 60 ) : “ Rather, the of import point is that the two watercourses are complementary: Positivist theory identifies assorted contract options, and the principal-agent theory indicates which contract is the most efficient under changing degrees of outcome uncertainness, hazard antipathy, information, and other variablesaˆ¦ ”

Problems of bureau theory

The major popularity of the application of the bureau theory to the relationship between stockholders and the board if managers produced a huge sum of research devoted to this issue. In fact, this phenomenon relates to those instances in which ownership and direction are represented by different persons. Bing each person maximizing its public-service corporation leads to the being conflicting places between the agent and the principal. This became the chief focal point of research, and justifies the demand of such an bureau theory.

This debatable is in the footing of the function of agent theory in the accounting patterns. Harmonizing to Bricker and Chandar ( 1998: 488-489 ) :“ Contracts between stockholders and directors are written in order to cut down bureau cost, and thereby, the dead weight loss in steadfast value as a consequence of the separation of ownership from control. Accounting is considered to play an of import function as an built-in portion of the contracts that define a house. For illustration, imparting agreements between a house and its creditors frequently contain several accounting based compacts. Accounting-based fillip programs are often a constituent of executive compensation programs.

Accounting steps are normally used in the public presentation rating of a house ‘s cost and net income centres. Watts and Zimmerman argue [ 1986, p. 196 ] : “ if accounting is an of import portion of the house ‘s undertaking procedure and bureau costs ( and therefore, house value and/or directors ‘ compensation ) vary with different contracts, accounting processs have the possible to impact steadfast value and/or the director ‘s compensation. ” This principle has given rise to several hypotheses sing the function of accounting information in market rating of houses and directors ‘ usage of accounting discretion.

Development of bureau theory

Agency cost is a major job with administration and with changeless fraud instances that are turning around the universe their needed to be major development of the theory in accounting patterns. A manner of developing the theory is to understate bureau costs that can be accomplished through communications, sharing hazards and benefits and seeking to equilibrate the scorecards. The theory has developed by set uping public presentation criterions, utilizing cost effectual procedures, cost direction tools and inducements have all helped the job of pull offing bureau jobs..

Accountancy provides information to establish future determinations on historical public presentations. Supplying accurate information about costs it is possible to foretell the consequence of future production. This position is peculiarly of import in the instance of, for illustration, authorities contracts, in which an agent- principal relationship is besides established. For illustration, Reichelstein ( 1992 ) draws upon the bureau theoretical accounts to explicate authorities contracts, demoing how bureau theory can be used to plan incentive contracts, and showing that the bureau theoretical accounts have really influenced managerial economic sciences.A different position is that accounting provides an chance of control from the agent over the principal.

In this regard, the penetrations about the relationship between the stockholders and direction were peculiarly of import in showing the function of accounting as cardinal information supplier.To that extent, it was suggested that accounting coverage is a consequence of the separation of ownership from direction phenomena. Hence, it can be argued that the coverage pattern is a consequence of the agent job and serves the control needed to verify the agent ‘s public presentation.Another position was the budget development based on historical histories. Contracts normally include a monetary value for production which has non taken topographic point yet. The pricing of these contracts has to be based on historical costs that can merely be provided by accounting.

To that extent, accounting pattern is non a consequence of the agent-principal job but is originated to avoid uncertainness in principal-agent relationships.

instance realted survey to bureau theory

Taking a premier illustration of Enron and its relationship with accounting patterns clearly show the affects of bureau theory within an accounting pattern can impact administrations. The prostration of Enron was wholly related to the accounting patterns adopted by the company. It has a figure of these questionable, and in some instances straight out deceitful, accounting patterns that pertained to the most dramatic prostration of a major company in old ages. An analysis of some of these accounting patterns brings to illume the jobs with the usage of constructs such as mark-to-market accounting and the usage of particular purpose entity ‘s ( SPE ‘s ) , the interrelatedness of bureau theory suggests that the basic ideals environing bureau theory applied to the Enron Case at some point in clip, nevertheless the continuance of this principal deteriorated as clip went on.The bureau theory was clearly an issue in Enron ‘s instance because the directors of the house were reassigning wealth from the stockholders to themselves in the signifier of stock public presentation. Not merely were there the Shareholders to Management bureau job there was besides an employer to employee bureau job. With respect to the stockholder to direction job, the stockholders had placed a big sum of decision-making capableness onto the direction squad and had non successfully monitored the agent ‘s behavior.

Given that the directors had all come to Enron with a strong repute, it was expected that they “ would move in the involvement of the stockholders. [ As such the stockholders ] had monitored the director ‘s public presentation really small ” ( Godfrey et al, 2008 ) . As a stockholder, it would hold been in the best involvements to implement monitoring costs to “ step, observe and control ” Schillings behaviour. Unfortunately this would non hold been plenty. The debut of Fastow, described as “ a mastermind ” in a figure of beginnings, allowed for the public presentation of Enron to look strong even in dire times. The usage of SPE ‘s and mark-to-market accounting allowed for the “ decrease of monitoring costs by incurring bonding costs [ in the signifier of quarterly statements ] ” that allowed Enron to execute better than it appeared.Another point that links is that the bureau theory is the “ the principal will compensate the agent harmonizing to the principals outlooks of how much the agent ‘s behavior is likely to be contrary to the principals involvements ” ( Godfrey et al, 2008 ) .

Given that directors of Enron were all major stockholders of the company the focal point was on driving the portion monetary value up which was done by a procedure called “ pump and shit ; this procedure involved purchasing up the portion monetary value and so selling out ” ( Enron: The Smartest Guys in The Room ) this allowed the managers to keep high wage because they were accomplishing high portion monetary values for the principals and besides allowed them to derive from portion monetary value rises before selling out at the top.Finally, the principal-agent relationship that occurs between Skilling and Fastow ( CEO of Enron ) is that of an employee to employer. This relationship is of import because it “ emphasises the importance of the ability to supervise employee ‘s work attempts ” ( Akdere, Azvedo, 2004 ) . Skilling and Ken Lay claim that they were unaware of what Fastow was making with respects to the fiscal statements, nevertheless, Skilling and Lay were moving as the agents for the stockholders every bit good every bit moving as the principals for Fastow. Their engagement in such minutess as the 1 with LJM were “ non merely disclosed to the board at a meeting which took topographic point in 1999, but the board approved of [ Fastow ‘s ] engagement, following a recommendation to this consequence from the so CEO and Chairman, Ken Lay ” ( Deakin, Konzelmann, 2004 ) . From this we can clearly see that Lay, Skilling and Fastow were all portion of the bureau job that occurred.


This study has shown that several countries of accounting have been affected by the bureau theory theoretical account. This theory has rebelliously had deductions in the fiscal accounting, direction accounting and in corporate finance. Nevertheless, the strongest statement that relates to bureau theory with accounting chiefly relies in the nature of both, the accounting and bureau theory rely on the being of contracts, these contracts rely at the nucleus of the relationship between agents and the principal. Furthermore bureau theory ‘s nucleus function is the hazard associated with the relationship whereas accounting reduces hazard by supplying information about the agents in action.

Additionally describing old behaviors of the agent demoing that the historical agent has kept the conditions of contract, may supply indicants for the principal about the future behavior of agents ; increasing trust degrees in the relationship and cut downing the hazard associated with dealingss.In decision, the current characteristics ( and patterns ) of accounting run into the bureau theoretical account jobs turn outing the information to avoid timeserving behaviors and guaranting that relational contracts are met.


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