Agency theory was developed by Stephen Ross and Barry Mitnick in 1976

Agency theory was developed by Stephen Ross and Barry Mitnick in 1976

Agency theory was developed by Stephen Ross and Barry Mitnick in 1976. The theory reports that management is an essential organ in an organization as it makes decisions and strategies to be followed; thus, it should be monitored regularly to check the effectiveness of the decision made on the profit maximization to the company (Donaldson & Davis, 1991). The profitability of the organization increases when there is good collaboration between the agent’s agents (top management) and stakeholders (shareholders) (Adams, 1994). The boards of the profit-making organizations need to align the interests of management with those of shareholders to have a sufficient understanding of working toward achieving a common goal (Schulze, Lubatkin & Dino, 2003). Besides, the theory reports that the top shareholders and boards should always keep the management on the check. They should regularly report on how the organization is doing financially to minimize them from working toward self-interest. The theory shows that the profit maximization is maximized when the agent and principal are working toward a particular purpose.

The theory is very significant to the business in the decision-making process and helps explain the role of top managerial staff in checking the directors of the firm and maximizing the profits generation (Gomez & Wiseman, 2007). The senior administrative staff as a governance mechanism helps in keeping on toes the managers who may pursue self-interest at the expense of shareholder’s wealth maximization objective and the board of director will effectively provide an oversight authority to guarantee that the interests of investors are not infringed by managers who are internal players in the firm they are serving (Kivistö, 2005). Therefore, this theory will inform the dependent variable, profitability in the current study.