1. S. Amir Hossein Ghazinoori
Faculty of Management
Advanced Theory in Organization & Management
1Amir H. Ghazinoori, ASB (UNSW)

2. Focus on
organizations & competition
has generated a very large &
ever growing literature
which can be divided to
four research streams
Why Do Firms Exist?
(Transaction Cost Economics / Neo-classical Economics)
Do those associated with a firm agree
about how it should be managed?
(Agency Theory) (Stewardship Theory)
Why do some organizations
outperforms others?
(Strategic Management Theory)
How can organizations Cooperate?
(Cooperative organizational economics)
2Amir H. Ghazinoori, ASB (UNSW)

3. Reasons to establish a firm (hierarchy)
1. To avoid the transaction costs of the price mechanism
• Discovering relevant prices
• Costs of negotiating deals
• Costs of writing/rewriting contracts
2. Haggling over division of surplus
Size determinants
1. The number and costs of transactions
• Upper limit: When the costs rise to the point where
internalising a transaction equals the cost of making
the transaction in the market.
• Lower limit: If the firms costs of transactions exceed
the markets costs it does not come into existence.
Ronald Coase
3Amir H. Ghazinoori, ASB (UNSW)

4. Think about the Patient-Dentist relationship!!!
AGENCY RELATIONSHIP occur whenever once
partner in a transaction (the principal)
delegates authority to another (the agent) and
the welfare of the principal is affected by the
choices of the agent (Arrow, 1985)
What is the Agency Problem?
4Amir H. Ghazinoori, ASB (UNSW)

5. The delegation of decision-making authority from
principal to agent is problematic:
• Interest of principal and agent may not be the same
• The Principal cannot perfectly & costlessly monitor the
actions of the agent
• Principal cannot perfectly and costlessly monitor and acquire
the information available to or possesses by the agent
(Asymmetric Information)
5Amir H. Ghazinoori, ASB (UNSW)

6. Two Essential Sources of Agency
Problem:
1. Moral Hazard:
Equates to hidden actions
2. Adverse Selection:
Equates to hidden info
• Information Advantage
• Information Disadvantage
6Amir H. Ghazinoori, ASB (UNSW)

7. • Agency theory argues that in the modern corporation, in which share
ownership is widely held, managerial actions depart from those required to
maximise shareholder returns (Berle & Means 1932; Pratt & Zeckhauser 1985).
• The owners are principals and the managers are agents and there is an
agency loss which is the extent to which returns to the residual claimants,
the owners, fall below what they would be if the principals, the owners,
exercised direct control of the corporation (Jensen and Meckling 1976).
• Agency Theory considers that delegation should be minimized as it leads to
abuse (Donaldson, 1995).
7Amir H. Ghazinoori, ASB (UNSW)

8. • Agency theory specifies mechanisms which reduce agency loss
(Eisenhardt 1989).
• Through the agency theory; the solution to agency problems is
to control them (shirking managers) more through closer
monitoring, stronger incentive system and bonds, or to integrate
vertically with suppliers or customers so that price negotiation
across organization boundaries is replaced by hierarchical
authority. (Jensen & Meckling, 1976; Aoki, 1990)
• Executive compensation schemes and Governance structures
(which refers to the high level authority system of an organization, including
particularly the structure for the control of executive management, the board of
directors) can to a degree protect the interests of shareholders &
minimize the agency costs.
8Amir H. Ghazinoori, ASB (UNSW)

9. • Agency Theory seems to adapt an unrealistic view of humans & organization
(Hirsch et al. 1990)
• There is a necessity of recognizing a broader range of human motives than
those drawn upon in conventional agency theory (Arrow, 1985).
• Are we always talking about Mr Economic?
Some human behaviour is emotional and not rational: (Herzberg, 1996; Parsons, 1951)
• Compulsive Behaviour
• Normatively Governed Behaviour
• Intrinsic Motivation
• Altruism
• Perrow (1986) & Others (Hirsch et al. 1990) argue that agency theory has an inherent
investor focus. (this criticism may not be inherent in theory)
• Agency theory assumes that firms are essentially homogeneous in their
transactions and agency governance structures. Consequently , it also cannot
argue about why some firms might outperform the others
9Amir H. Ghazinoori, ASB (UNSW)

10. • Agency theory rejects the idea that effective structures vary
between mechanistic and organic upon the task-uncertainty
contingency and instead holds that mechanistic structures are
appropriate. (Donaldson, 1995)
• Agency Theory fails to find consistency that more controls on
managers produce superior results calls into question the whole
assumption of agency theory that managers are lazy or devious
defrauders of shareholder wealth.
• The evidence rather more shows that managers perform better
under self-regulation, which is consistent with the more benign
view of managers.
10Amir H. Ghazinoori, ASB (UNSW)

11. “Although agency theory addresses
manager-principle interest divergence,
additional theory is needed to explain
what, if anything, causes interests to
be aligned” and to explain other types
of human behaviour ….
11Amir H. Ghazinoori, ASB (UNSW)

12. • Stewardship theory defines situations in which managers are
not motivated by individual goals, but rather are stewards
whose motives are aligned with objectives of their principals.
• Given a choice between self-serving behaviour and pro-
organizational behaviour, a steward’s behaviour will not depart
from the interest of his/her organizations.
• Because the steward perceives greater utility in cooperative
behaviour and behaves accordingly, his or her behaviour can be
considered rational.
• If the executive’s motivations fit the model of man underlying
stewardship theory, empowering governance structures are
appropriate. “He or she can be trusted”.
12Amir H. Ghazinoori, ASB (UNSW)

13. • So, why isn’t there always a steward relationship, rather than an
agency relationship?
• The answer lies in the risks that principles are willing to assume.
Within the governance contract, owners must decide how much
risk they are willing to assume with their wealth.
• Implementing stewardship governance mechanisms for an agent
would be analogous to turning the hen house over to the fox.
13Amir H. Ghazinoori, ASB (UNSW)

14. 14
• There are a number of dimensions on which agency theory
assumptions differ from assumption of stewardship theory:
 Psychological Factors
Motivation
Identification
Use of Power
 Situational Factors
Management Philosophy
Culture
Power Distance
Amir H. Ghazinoori, ASB (UNSW)

15. 15
Agency Theory Stewardship Theory
Model of Man
Behaviour
Economic Man
Self-serving
Self-actualizing Man
Collective Serving
Psychological Mechanisms
Motivation Lower order / economic needs
Extrinsic
Higher order needs (growth, achievement,…)
Intrinsic
Social Comparison
Identification Power
Power
Other Managers
Low value commitment
Institutional (legitimate, coercive, legal)
Principal
High value commitment
Personal (expert, referent)
Situational Mechanism
Management Philosophy
Risk Orientation
Time Frame
Objective
Cultural Differences
Control Oriented
Control Mechanisms
Short Term
Cost Control
Individualism / High Power distance
Involvement Oriented
Trust
Long Term
Performance Enhancement
Collectivism / Low Power distance
Source: Davis, Schoorman, and Donaldson (1997: 39)
Amir H. Ghazinoori, ASB (UNSW)

16. Minimize Potential
Costs
Mutual Agency
Relationship
Agent Acts
Opportunistically
Principle is Angry
Principle is Betrayed
Principal Acts
Opportunistically
Manager is Frustrated
Manager is Betrayed
Maximize Potential
Performance
Mutual Stewardship
Relationship
Agent Steward
AgentSteward
Principal’s Choice
Manager’sChoice
1
43
2
16
Source: Davis, Schoorman, and Donaldson (1997: 39)
Amir H. Ghazinoori, ASB (UNSW)

17. Arrow, K. J. (1985). Informational structure of the firm. The American Economic Review, 75(2), 303-307.
Barney, J., & Hesterly, Organizational Economics: Understanding the Relationship between Organizations and Economic
Activity. Chapter 4 in Clegg, Stewart R., Stewart Clegg, and Cynthia Hardy, eds. Studying organization: theory
and method. Sage, 1999, London, 109-141.
Berle, A. A., & Means, G. G. C. (1932). The modern corporation and private property. Transaction Books.
Coase, R. H. (1937). The nature of the firm. economica, 4(16), 386-405.
Davis, J. H., Schoorman, F. D., & Donaldson, L. (1997). Toward a stewardship theory of management. Academy of
Management review, 22(1), 20-47.
Donaldson, L., & Davis, J. H. (1991). Stewardship theory or agency theory: CEO governance and shareholder returns.
Australian journal of management, 16(1), 49-64.
Donaldson, L. (1985). In defence of organization theory: A reply to the critics (Vol. 9). CUP Archive.
Donaldson, L. (1995). American anti-management theories of organization: A critique of paradigm proliferation (Vol.
25). Cambridge University Press.
Eisenhardt, K. M. (1989). Making fast strategic decisions in high-velocity environments. Academy of Management
journal, 32(3), 543-576.
Hirsch, P. M., Friedman, R., & Koza, M. P. (1990). Collaboration or paradigm shift?: Caveat emptor and the risk of
romance with economic models for strategy and policy research. Organization Science, 1(1), 87-97.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership
structure. Journal of financial economics, 3(4), 305-360.
Perrow, C., Reiss, A. J., & Wilensky, H. L. (1986). Complex organizations: A critical essay (Vol. 3). New York: McGraw-Hill.
Pratt, J. W., & Zeckhauser, R. J. (1985). Principals and agents: an overview. Principals and agents: The structure of
business, 1, 12-15.
17Amir H. Ghazinoori, ASB (UNSW)

18. 18Amir H. Ghazinoori, ASB (UNSW)