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CMA Foundation · Fundamentals of Business Economics and Management · Stewardship Theory and Agency Theory of Management

Sharma Textiles Ltd. is owned by outside shareholders and run by a hired CEO. The board fears the CEO may expand into low-return projects for personal prestige. Which theory explains this concern, and what is the cost of addressing it called?

This is explained by agency theory, where the principal-agent conflict arises from separation of ownership and management. The costs of controlling it, such as monitoring and bonding expenses plus residual loss, are called agency costs.

  1. AAgency theory; agency costs such as monitoring and bonding expensesCorrect
  2. BStewardship theory; stewardship costs
  3. CAgency theory; sunk costs
  4. DStewardship theory; opportunity costs of trust

Explanation

The separation of ownership and control with a self-interested manager is the agency problem. Expenses to reduce it (monitoring, bonding) plus residual loss are agency costs. Stewardship theory does not assume such conflict.

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