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Agency theory

Jenson and Meckling (1976) define
agency theory as a relationship between the contractor and another party (the
agent) in which the contractor will delegate some decisions to the agent. In
this relationship, the contractor will hire an agent to perform a specific task
given to them. For instance, in partnerships, the principals are the investors
of an organization, assigning to the specialist i.e. the administration of the
organization, to perform errands for their sake.

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Assumptions on Agency theory

There are three assumptions on
agency theory that are related to human behaviour they are humans have bounded
rationality which means that there are breaking points to what individuals
know. Second one is humans are selfish which implies that individuals put their
own needs before other individuals. Final assumption is humans will always seek
to maximise their own utility such as wealth and health over other individuals.

Agency costs

Agency costs are costs that are
internal that must be paid to, an agent following up for the benefit of a principle.
After given the assumptions by the agency theory the interests between the
contractor and the agent is divergent, this leads to agency cost being
incurred. These are Monitoring costs by the principal which indicates whether
individuals are performing very well. Second one is Bonding costs by the agent
which indicates whether the individual is reporting back to the principals to demonstrate
performing. The final one is Residual Loss is the decline in the value of the
firm that emerges when the manager reduces his rights. William (1988) suggest
that this is the key cost; however, the other two are brought are only occurred
when they yield financially decreases in the residual loss.

example, when an agent demonstrations reliably with the principals interests,
agency loss is nothing.  The more an
agency pay attention to the principles interests, the more agency loss
increases. Therefore, the agency should focus more on ideas created by them
instead of taking note from the principle, then agency loss becomes high.

Agency problem

Agency issues emerges because of
the disagreement or dissociate of attention between the contractor and the
agent. Agency problem in finance is occurred when there are conflict between
the manager and the shareholders in the business. There are different types of
agency relationship in finance for instance managers and shareholders. Managers
employ experts (supervisors) who have specialized aptitudes. Managers may take
actions, which are not to the greatest advantage of shareholders. This is
generally when the managers are not owner of the property i.e. they don’t have
any shareholding. The involvement between the managers will be in conflict with
the interest of the owners. Murphey (1985) argues that managers tend to build
the extent of organizations regardless of whether it hurts the interests of
investors, as regularly their compensation and distinction are decidedly
corresponded with organization measure. Therefore, this causes conflict between
the manager, who tend to esteem development, and investors, who are orientated
towards the boost of the estimation of their offers.

The agency problem in the corporation

According to Smith (1776) the
executives of such like joint stock in organizations, in any case, being the
managers of other individuals’ cash than their own, can’t be very much expected
that they should watch over it with a similar watchfulness with which the
accomplices in a private co-partner as often as
possible watch over their own.

The organisation in agency theory

Jenson and Meckling (1976)
suggested that organisations just legitimate fictions which fill in as a nexus
for an arrangement of contracting connections among people.

The role of board of directors:

Garrat (1997) defines the
function of the board directors as follows:

Determine the company’s purpose and “ethics”;

Decide the direction, that is, the strategy;


Monitor and control managers and CEO; and

Report and make recommendations to shareholders

Board of directors regularly have
power more than one board. Executives are additionally known to have a few
duties and regularly clashing necessities. They have time requirements what’s
more, subsequently need to precisely deal with their endeavours for most
extreme outcomes. The main purpose that tests the capability of a board is that
of observing and control of the presidents and their execution. The more
noteworthy the level of observing, the more prominent the likelihood of
achievement or upgraded budgetary execution












Resourced based view

Barney (1991) define Resourced-
based theory when firms resources and included in all assets, for instant their
abilities, organizational procedures, firm properties, data, information and so
on, these are controlled by a firm in order for the firm to execute
methodologies that enhance its proficiency and adequacy.

All the assets in the firm are
heterogeneously disseminated crosswise over contending firms. Also, all the assets
in the firm are defectively portable which influences this heterogeneity to
persevere after some time


According to Barney (1991) “competitive
advantage in a firm is when it is implementing a value creating strategy not
simultaneously implemented by any current or potential competitor”.              An asset will deliver competitive
advantage when it produces an incentive for the association, and is done in a way
that can’t without much of a stretch be sought after by challengers.

The resourced-based theory of
firms focuses on main two assumptions and they are:

diversity is also known as asset heterogeneity. This resource relates to
whether a firm claims an asset or ability that is likewise owned by various
other contending firms, which means that the asset can’t give a competitive
advantage. For instance of asset resource diversity, think about the
accompanying: a firm is attempting to choose whether to execute another IT
item. This new item may give a competitive advantage to the firm if no
different contenders have a similar usefulness. In the event that contending
firms have comparative usefulness, at that point this new IT item doesn’t pass
the ‘asset diversity’ test and for that reason competitive advantage does not

immobility alludes to an asset that is hard to get by contenders in light
of the fact that the cost of creating, securing or utilizing that asset is too
high. For instance of resource immobility, a firm is endeavouring to choose
whether they should purchase an ‘off-the-rack’ stock control framework or have
one assembled particularly for their necessities. On the off chance that they
purchase an off-the-rack framework, they will have no competitive advantage in
the market over others on the grounds that their opposition can execute a
similar framework. On the off chance that they pay for a modified arrangement
that gives particular usefulness that exclusive they execute, at that point
they will have a competitive advantage, expecting a similar usefulness isn’t
accessible in different items.

Overall, these two assumptions
can be utilized to decide if an association can make a maintainable competitive
advantage by giving a structure or deciding if a procedure or innovation gives
a genuine favourable position over the commercial centre. By using these
assumptions on RBV it shows if sustainable competitive advantage can be
produced and sustained in all firms. 

Types of resources:

There are three types of
resources Barney (1991):

1. Physical
capital resources (physical, tangible, technological, plant and equipment)

2. Human capital
resources (training, intangible, experience, insights)

3. Organizational
capital resources (formal structure)

Transaction costs

Transaction costs of theory is
prompted by Ronald Coase in 1937, he states the theory as the cost of finding
good source or service from the market and not given from inside the firm. In
Coase’s (1937) theory he suggests that ‘the main reason why it is profitable to
establish a firm would seem to be that there is a cost of using the price
mechanism’. Also, Coase (1937) brings up that vulnerability and human instinct
would be the wellsprings of the cost that is made in advertise exchanges.

A transaction cost t is the cost
associated when making a trade. A trade can be internal or external. For
instance, an external trade happens when two separate organizations are
included.  Whereas, an internal
transaction costs are the expenses to make and observe the settlement.


Williamson (1975) developed the
theory of transaction theory as he fully concentrates on the connection between
traits of transactions and qualities of the administration structures that used
to provide these transactions. Williamson does not

Williamson does not accept that
all people are opportunistic to a similar degree, “some individuals are
opportunistic some of the time and… differential trustworthiness is rarely
transparent ex ante. As a consequence, ex ante screening efforts are made and
ex post safeguards are created” (Williamson, 1985).

Critiques of transaction theory

There are many transaction costs
economics critiques. With respect to vulnerability, transaction costs emphases
behaviour vulnerability that builds up other transaction costs in the market.
Nonetheless, there might be different sorts of vulnerability that expansion
different sorts of cost. This issue is proposed by Demsetz (1988), who contends
that transaction costs is only considered by the cost of transactions overlooks
at other costs, for example, creation cost. This is fairly amusing in light of
the fact that transaction costs at first was acquainted to be important to
transaction cost economizing, which has been disregarded some time recently,
and instead it has been concentrating on innovation and construction costs
(Williamson, 1975).

What are the boundaries in the Transaction cost theory?

One of the boundaries in
transaction theory is that expanding the firm. The reason for this is because
when a firm chooses to develop its boundaries to deal with the trade
internally, there will be new internal exchange costs. These are the future
expenses that should be planned and arranged internally. However, if these
trades were not done some time recently, then these internal transaction
expenses can be significant. Overall, Coase (1937) states that organizations
should keep on expanding as long as internal transaction costs are not as much
as external transaction costs for a similar sort of trade.

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