Governance: Agency

Theory
Introduction
 Agency Theory is important in organisational governance. The 1970s theory by economists
Michael Jensen and William Meckling describes, explains, and solves problems in partnerships
where one person, the principle, assigns labour to another, the agent.
 Agency connections may occur between shareholders and management of a firm, or between
employers and workers. In some cases, the agent performs duties or makes choices for the
principal.
 Agency Theory emphasises the "agency problem" or "principal-agent problem" in agency
interactions. Due to principal-agent conflict of interest, this issue develops. Agents may follow
their own interests rather than that of principals. This may cause primary conflicts and hazards.
 Principals use contracts, incentives, and monitoring systems to align agents' behaviour with
theirs. These methods involve agency costs.
 Thus, Agency Theory helps build optimum organisational structures and methods to minimise
agency difficulties and costs, providing effective and efficient governance. It aids company
governance by balancing shareholder, management, and employee interests.
Case Study: Enron Corporation
 The Enron Corporation was a Houston, Texas-based American energy company. During
its zenith, Enron emerged as a prominent global entity, operating in the sectors of
electricity, natural gas, communications, and pulp and paper. It purportedly generated
revenues amounting to approximately $101 billion in the year 2000. Nevertheless, it
was disclosed towards the conclusion of 2001 that Enron's purported financial state was
largely propped up by a methodical, organised, and ingeniously devised accounting
fraud, commonly referred to as the Enron scandal.
Analysis through Agency Theory

 In this particular scenario, the agents, referring to the top management of Enron, engaged in
actions that prioritised their personal interests, thereby deviating from the well-being of the
principals, who are the shareholders. Enron's financial statements were manipulated by the
management in order to present inflated revenue figures and conceal debt. The aforementioned
fraudulent conduct yielded monetary benefits for the executives, but ultimately culminated in the
insolvency of the organisation, thereby obliterating the investments of numerous stakeholders.
 This scenario exemplifies an agency problem, characterised by a notable misalignment of
interests between the managerial personnel and the shareholders. The management, driven by
individual financial gain and enabled by inadequate regulatory supervision, acted in a manner
that was inconsistent with the interests of shareholders.
 In order to mitigate the occurrence of such misalignment of interests, Agency Theory posits a
range of mechanisms, including contracts, incentives, and monitoring systems. The mechanisms
in place in the Enron case were unsuccessful. The auditing system, intended to serve as a crucial
monitoring mechanism, failed to operate efficiently due to the complicity of the auditors (Arthur
Andersen) in the fraudulent activities.
Conclusion
 The Enron scandal, which unfolded in the early 2000s, stands as a vivid illustration
of the inherent risks that can emerge when there is a misalignment of interests
within principal-agent relationships. This particular case serves as a poignant
reminder of the potential problems that can arise when the goals and motivations of
those in positions of authority diverge from the best interests of the stakeholders
they are meant to represent. This statement highlights the significance of
implementing efficient governance mechanisms and emphasises the criticality of
transparency, accountability, and regulatory oversight in safeguarding the interests
of shareholders. This particular case study is frequently utilised as a pedagogical
tool in academic settings to explore and analyse the intricate dynamics of corporate
governance, ethics, and agency theory within the realm of business and
management education.
Thank You