Critical Thinking and Analysis #1 p. 102 in textbook
1. What is the relationship among agency theory, economic consequences, and
signalling? Explain in depth
The relationship between agency theory, economic consequences, and signaling are very close.
Agency theory is at the center of many competing groups. There exist a preference of managers
favoring to increase their bonus or compensation at the detriment of shareholders. Shareholders
tend to lose as a result when managers work on behalf of their self-interest. This loss could either
be a reduction in the amount of dividends or devaluation of the share price. Meanwhile, creditors
of the company are concerned with getting their interest and principal. Economic consequences on
the other hand refers to the how accounting standards tend to favor a group at the expense of others.
This would very much complement agency theory consistently. Signalling, however focuses on
shareholders and prospective investors (prospective shareholders). They do not have any
agreement or disagreement between agency theory and economic consequence, however, the fact
that it also makes accounting regulation unnecessary makes it consistent with agency theory.
Agency theory is of the belief that adequate relationship between management and shareholders,
and complying with GAAP and other regulatory requirements is paramount should management
intend to derive optimum maximization. Signalling is complementary, in the sense that it makes
regulation unnecessary and would allow companies to voluntarily provide positive and negative
information to shareholders, and this is especially worrisome when you factor in the competitive
nature of capital market. So therefore, Signalling and agency theories are consistent theories. The
relationship between them refers to the fact that one set of sufficient conditions of signaling theory
is at least consistent with one set of sufficient conditions of agency theory. There are also some
overlaps between these theories such as rational behavior being a prime example and also the
implicitness of signaling theory in some bonding devices of agency theory. When these two
(Signalling and Agency theory) become very consistent with eachother, Economic consequences