There are certain theories that explain business relationships, which are used to understand and explain these relationships. In particular, the theories provide a means to understand business challenges. There are problems in business that may be a result of genuine misinformation or may actually be caused by clashing business interests.
Agency Theory vs. Stakeholder Theory: An Overview
The agency and stakeholder theories are often used to outline the interests of shareholders, employees, customers, the public and, vendors. Many challenges that manifest within the business world as a result of incomplete information, miscommunication and conflict may be explained using these two theories.
Agency theory describes the problems that occur when one party represents another in business but holds different views on key business issues or different interests from the principal. The agent, acting on behalf of another party, may disagree about the best course of action and allow personal beliefs to influence the outcome of a transaction. The agent may also choose to act in self-interest instead of the principal's interests. This may result in conflict between the two parties and might be an agency problem. Agency theory tends to focus mainly on the interest of shareholders.
Stakeholder theory describes the composition of organizations as a collection of various individual groups with different interests. These interests, taken together, represent the will of the organization. As much as possible, business decisions should consider the interests of this collective group and advance overall cooperation. Conflict represents an erosion of these interests. Bringing these distinct groups together to reach an agreement may not always be possible, so business decisions must consider each point of view and optimize the decision-making to include all voices.
With agency theory, there are differences in what the principal and the agent think is the best course of action, also known as the principal-agent problem. The agent theory can arise in such cases as portfolio managers—who are the agents—managing assets on behalf of an individual or company—the principal. Agency loss comes about when the principal suggests a loss happened due to an agent’s actions that were not in the best interest of the principal.
With stakeholder theory, there’s a difference in the priorities for stakeholders, either internal or external. Internal stakeholders can include employees, investors or owners. External stakeholders include those that are affected by a company’s decisions, such as suppliers or creditors.
An example would include a conflict between company management and shareholders. The management may make decisions that do not necessarily enhance shareholder value, which is in conflict with shareholder interests. Performance-based compensation, which ties management incentives to shareholder value, is one way companies look to address the stakeholder theory. However, this does come without its own issues, which includes trying to boost short-term performance at the sacrifice of long-term growth.
- The agency theory looks to outline the interests of a principal and an agent, which can include an individual and a financial planner.
- The stakeholder theory suggests there are differences between individual groups within an organization, such as the employees, investors, and suppliers.
- Agency theory primarily focuses on the interest of the shareholder(s), while principal theory includes the entire range of stakeholders.