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one party (the Principal) engages another party (the agent) to perform some
services on their behalf”. (Jensen & Meckling, 1976). Jensen and Meckling
Agency theory consider in account from long timeline, especially in the area of
the business and economics. Study have done on agency theory by different
scholar in various field such as sociology (e.g., Eccles, 1985, White, 1985)
1985, 1988; Kosnik, 1987), Marketing (Basu, Lal,Srinivasan, & Staelin, 1985),
pricing of initial public offerings, management have full control over what
types of methods sent out to their investors. (Allen, F.; Faulhaber, G.R. (1989)
Table 1
Risk averse
Self-interest
Information Assumption Information like purchasable
commodity
Organisational Assumption Information asymmetry between
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making.
insiders know more about their own firm than debt financier and
Bonding cost: - Monitoring cost is finally suffered by the agent this cost
is born by the agent this are not financial all the time as it may also
cost.
interest agency loss arises this situation can be define as residual cost.
theory:-
Table 2
Serial Authors Agency variables Investigation Dependable Model Companion Outcom
no stream Variable theory e
1 Amihud& Manager vs. Positivist Conglomerate 309 Fortune None Support
Lev(1981) Owner controlled mergers & 500 firms
diversification
2 Walking & Management’s Positivist Managerial 105 U.S Shareholder Support
Long(1984) equity & options resistance to firms welfare &
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Moral hazard: - moral hazards first explain by Jensen and Meckling (1976).
They assume a situation where there is a single manager who owns the firm
investing in the positive (NPV) net present value projects here his ownership
diverse. Manager may select investment best suited to personal skill through
this Value to the firm for individual manager and also increase the cost of
managerial efforts.
Grandiose Managerial visions deliver more concern to the moral hazard. When
manager required fund for major investment project than earning retentions
acquired along with gain in new capital. Due to this management encourage
Time horizon agency conflicts: - With respect to the timing of cash flow
future all future cash flow of the company undertaken by the shareholder.
flow, approaching to short term high return on expenses of long term positive
or when they plan to leave the company. It has been find that accounting
earning tend to higher in year when CEO (chief executive officer) leave their
position.
Risk in any business was critical during period of 1960 and 1970 economist find
risk sharing among groups and individual. Risk occurs when corporate parties
have different desire toward their goal agency theory widened this risk sharing
literature to include the so called agency problem. Agency theory tries to draw
this relationship using the metaphor of a contract, (Jensen & Meckling, 1976)
party (the agent) delegates work to another (the principal). Agent works for
principal.
The ideas of agency theory has become much more important now than ever
companies from last one decade such as WorldCom in 2001 Enron in 2001 and
Agency theory plays very important role in planning and management of on-
and financing choice has been thoroughly explain including empirical model.
equity, debit finance and convertible debt. Following calculation will be helpful
in further findings,
Equity
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One possibility in the listed company’s issue of the equity implement by the
manager to issue equity. When the project is undertaken, cash flow from
X + R – kd,
Here
(X + R − kd)( т ),
(X + R − kd)(1 − т) − (1 − k) d
(X + R)(1 − т) − d + k т d,
Which mean, after tax cash flow from unlevered firm, minus cash flow to debt
Here ∂ Denote the share of the ownership over the cash flows allocated to the
outside financier, i.e. the dilution. At the end of the period outside financiers
obtain:
∂ [(X + R) (1 − т) − d + k т d],
Debt financing
compensation.
To prove this equation it is assume that debt d is senior and the new debt D is
effectively defaults on its debt, the corresponding costs and financial distress
financial distress and default both events have to collapse into a single event,
R+X<D+d
It means when the earnings before taxes and interests were not enough to
This case lead to the cost of financial distress, create by the junior debt
legal fees, economic costs, firms face problems while reducing their value
In this situation, at the end of the period the manager obtains this equation
This mean the unlevered firm manager obtains the after tax cash flow, plus the
Here 1(R < D + d − X) is the indicator variable captivating the value one when
Convertible debt
debt into the fraction ᵞ of equity. In the end when cash flow (R) is realized. This
ᵞ
Here {(R + X) (1 - т) – d + kтd} > D
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ᵞ
Min {R + X – d, Max {D, ([R + X] [1 – т+ – d + k т d+)} - c (R + X – d) 1 (R < D + d –
X},
Convertible bond is only done by equity here D=0 and as far as concern about
ᵞ
debt which is particular case for T > D, and the value of ᵞ and D is never ideal
model to recognize the elements of the size of the internal audit function in
study were important descriptive power for the agency model. Precisely model
suggest a positive relationship among the size of the IAF (internal audit
function) and the diffusion of ownership, also approve the monitoring role of
Internal audit function, following variable has included in the study of the
hypothesis.
IAF.
means more chance to align their preference with those of outside owners
owner managers. (Francis and Wilson, 1988) To increase value of the firm they
have incentives as well. But manager have lesser amount of proportion of his
companies’ shares even in recent years it has been seen because of increasing
interest of the managers and shareholders as more aligned will be the interest
ownership may involve in the allocation resource and moral hazard problems
in ways that are not reliable with the interest of the non-managing
Specifically, the higher the divergence in the preference of the manager and
owner more diffused the ownership of a company, and lower the control of
agent action by the principal and the lower observe ability, vice versa. As the
Significance of this conclusion is that larger the internal audit functions need to
and divisions. Fama (1980) also used agency theory to inspect the hierarchical
proposes that it is more problematic for the top management in bigger firms to
oversee the firm, which makes a higher demand for internal auditing to
paper offers a positive correlation between company size and the demand for
both external and internal auditing (Carcello et al., 2005b). Top management
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1982). The size of the internal audit function is positively related to the
company size.
the need for monitoring through auditing required as the percentage of debt in
a company’s capital increase (cf. Chow, 1982; Francis and Wilson, 1988).
Previous study (e.g., Chow, 1982; Abdel-Khalik, 1993; Winters, 1998 and
between the demand for external auditing and the level of debt. This outcome
holders. As it has been argued by Watts and Zimmerman (1986), that auditor
promise lessens lenders’ monitoring costs. Carcello et al. (2005b) describe that
auditing. Lead to the positive relationship between the size of the IAF and
proportion of debt.
means of direct supervision the operations of a company with only one or few
reduced observe ability in the hierarchies may result into loss of control. This
more communication will become distorted when longer chain will occur (Katz
Belgian companies that were known to have an internal audit function and
these 260 companies are identified. Data taken from sources: for domestic
Belgian companies, the 2005 annual reports from the Belfirst database to
Here
financial sector.
variable (0/1)
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(0/1)
Org_Complex (+)
Result: -
Outcomes of this study are that IAF needed to monitor the interests in more
also throw light on external auditing that external auditing also play a
reducing agent/principal problem and also find that internal audit in corporate
governance is growing.
Conclusion: -
This paper mainly emphasised on the agency theory and presents structural
study on structure of agency theory and case study on several industries. It has
been found that earlier studies presenting that external auditing plays a
model Agency theory presents estimation of optimal agency cost and finance
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Fama, E. (1980). ‘Agency problems and the theory of the firm’. Journal of Political
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Francis, J.R. and Wilson, E.R. (1988). ‘Auditor changes: a joint test of theories relating to
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Design and Behavior: 347-370. New York: Wiley.
Brian W Kulik, agency theory reasoning and culture at enron in research of a solution, 2005
[online] Available http://www.jstor.org/stable/25123568 (assessed on 19/11/2010)