Agency theory can best be described as:

• A. The relationship between top management and the board of directors.
• B. The relationship between the board of directors and shareholders.
• C. The relationship between top management, the board of directors, and shareholders.
• D. The relationship between the external auditors and top management.

Answer: (C)

Agency theory examines the conflicts that arise in the principal–agent relationship within a corporation and how governance structures monitor and align incentives to protect owners’ interests. In practice, the principals are the shareholders, the agents are top management who run the company, and the board of directors serves as the governance intermediary that oversees management on behalf of shareholders. This triadic relationship—shareholders, top management, and the board—captures how information asymmetry and differing incentives can lead to agency costs, and how monitoring and incentive systems (like the board’s oversight and executive compensation) seek to align interests and reduce those costs. The other options omit important parts of this dynamic: focusing only on management and the board ignores the owners’ interests, or focusing on auditors and management misses the principal–agent core. The best description, therefore, is the relationship among top management, the board of directors, and shareholders.