What does agency theory analyze in corporate governance?

• A. Agency theory analyzes conflicts between owners (principals) and managers (agents) due to information asymmetry and divergent interests, motivating governance mechanisms to align incentives.
• B. Agency theory argues that owners should have no oversight of managers.
• C. Agency theory focuses on marketing strategy rather than governance.
• D. Agency theory claims governance is unnecessary if information is transmitted.

Answer: (A)

In corporate governance, agency theory focuses on the tensions that arise when owners (principals) hire managers (agents) to run the company, and information asymmetry plus divergent interests give managers the opportunity to act in ways that may not align with owners’ goals. Because owners often can’t perfectly observe day-to-day decisions, managers may pursue their own preferences, such as empire-building or short-term perks, rather than maximizing shareholder value. This motivates the design of governance mechanisms—like performance-based pay, monitoring by the board and auditors, and clearly defined contracts—that align incentives and reduce moral hazard.

That framing explains why governance exists at all: to bridge the gap created by information gaps and misaligned incentives. The other statements miss the core idea by suggesting no oversight, focusing on marketing, or claiming governance isn’t needed if information is transmitted—that ignores the fundamental problem agency theory addresses: information asymmetry and incentive alignment.