What issue does agency theory examine and why is it important in a public corporation rather than in a private corporation?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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Agency theory essentially says that whenever one person or group of people (called the principals) hires another person or group (the agents) and gives them authority to make decisions, conflicts can arise.  The conflicts can arise when the interests of the principals and those of the agents are not perfectly aligned with one another.  Agency theory, then, examines the conflicts of interest that can arise between principals and agents.  This is much more likely to be a problem in a public corporation than in a private one.

The problem addressed in agency theory typically arises when stockholders hire managers to run their company.  The personal best interests of the manager may not be the same as the best interests of the stockholders.  This problem is minimized in a private company.  In a private company, the owners are generally the managers or are very closely tied to the managers.  Therefore, there is not the same potential for conflict between the principals and the agents.

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