Business Ethics and Corporate Governance, Second Edition

THEORETICAL BASIS—AGENCY COSTS

The most fundamental theoretical basis of corporate governance is agency costs. Shareholders are the owners of joint-stock, limited liability company, and are its principals. By virtue of their ownership, the principals define the objectives of the company. The management, directly or indirectly selected by shareholders to pursue such objectives, are the agents. While the principals might assume that the agents will invariably do their bidding, it is often not so. In many instances, the objectives of managers are quite different from those of the shareholders. This divorce between ownership and management leads to agency costs, which in turn leads to the need for corporate governance.

Two broad instruments that ...