Ethical Accounting – Organizational Ethics and Corporate Governance (C03) Practice Test

Agency theory examines the relationship among the owners of a firm and the people who run it, with governance structures in between. In a corporation, shareholders are the principals who own the company, top management are the agents who run it day to day, and the board of directors acts as the representative and monitor for the owners. The theory focuses on how to align the managers’ decisions with shareholders’ interests and how to reduce costs that arise when managers pursue their own goals instead of maximizing shareholder value. This coupling of top management, the board, and shareholders best captures the governance dynamic studied by agency theory, whereas relationships with customers, regulators, or lenders involve different kinds of interactions. The board’s oversight and alignment of incentives are central to addressing the agency problem and ensuring that management acts in the owners’ best interests.