agency theory

The relationship between two parties, a *principal and an *agent, in which the latter represents or acts on behalf of the former. *Agency costs may arise if the goals of a principal and agent are not congruent: an agent, in other words, may be tempted to act in self-interest to the detriment of the principal. The relationship between a corporation’s investors and its *management is often described in terms of principal and agent, in so far as a corporation’s managers act as agents on behalf of investors. The monitoring of the proper functioning of this relationship between investors and management is frequently portrayed as the main purpose of external auditing: the audit fee is often viewed as "the cheapest form of insurance against defaults in the principal-agent relationship in corporate activity" (Lee, 1993, 125). However, the notion of the role of the modern external auditor as an impartial referee in corporate agency relationships has been challenged by the *critical accounting movement, and by advocates of *stakeholder theory who bring more players into the web of relations and responsibilities created by corporations. Some commentators on *corporate governance suggest that a company’s *board of directors acts as the main monitoring body of the agency relationships between investors and managers, and that the appointment of external auditors is simply one means of supporting the agency function carried out by the board of directors. However, other commentators bracket the board of directors with an organization’s management as agents who act on behalf of investors. Further reading: Berle and Means (1932); Chwastiak (1999); Jensen and Meckling (1976)