In this article published in the Academy of Management Review, Davis et al. (1997) analyses two approaches to governance: (1) agency theory and (2) stewardship theory.
Under agency theory, both agents (managers) and principals (shareholders) seek to maximize their individual utility. Losses to the principal result from interest divergence within the agency theory framework. As a result, principals design governance systems in ways that limit potential losses to their utility. The objective in agency theory is to reduce the agency costs incurred by principals by establishing internal controls. When this mechanism fails, more expensive external control mechanisms (e.g., acquisitions, divestitures and ownership amendments) will emerge to control self-serving managers. Alternative executive compensation schemes and governance structures are prescribed to protect shareholder interests. One scheme consists in establishing financial incentives subject to the successful achievement of shareholder objectives (e.g., long-term rewards tied to firm performance). Financial incentive schemes are desirable when the agent has a "significant informational advantage and monitoring is impossible". A second mechanism is governance structure, mainly through the role of board of directors. According to the authors, the limits of agency theory are determined by its model of man. Agency theory assumes a individualistic, opportunistic and self-serving model of man.
Stewardship theory, on the other hand, examines situations in which executives as stewards are motivated to act in the best interests of their principals. The model of man under stewardship theory is based on "a steward whose behavior is ordered such that pro-organizational, collectivistic behaviors have higher utility than individualistic, self-serving behaviors." The steward values more cooperation than defection. Stewards believe their interests are aligned with that of the corporation and its owners, they possess intrinsic motivation. If the manager's motivations correspond to the model of man under stewardship theory, empowering governance structures and mechanisms are appropriate. Therefore, under stewardship theory, focus is on empowerment rather than on monitoring and control.
The following questions arise from reviewing the article:
(1) Is there a model of man that best fits the observed behavior of managers in an agency relationship?
(2) What is the role of extrinsic and intrinsic motivation in the behavior of executives?
(3) How does the agency and stewardship theory shape the compensation contracts of managers?
(4) What are the critical determinants of intrinsic motivation?
(5) What is the importance of the process of identification within the stewardship theory framework?
(6) According to the authors, in an unstable environment, which approach is more effective: control-oriented or involvement oriented approach? Why?
(7) Do you agree with the proposition that people in a low power distance culture are more likely to develop principal-steward relationships than are people who are in a high power distance culture?
(8) Will an individualistic culture tend to agency theory or stewardship theory? What about a collectivistic culture?
(9) Why is the choice between agency and stewardship relationships similar to the decision posed by a prisoner's dilemma? What would be the Nash equilibrium?
The article can be found here:
