Agency theory

In organisational studies, agency theory is said to be the dominant theoretical framework on governance research (Davis, Schoorman and Donaldson, 1997; Cornforth, 2003). It is considered to be both an important and controversial theory (Eisenhardt, 1989). Ross claimed:

The relationship of agency is one of the oldest and commonest codified modes of social interaction…essentially all contractual arrangements, as between employer and employee or the state and the governed…contain important elements of agency (1973:134).

Agency theory can be described as an economic approach to governance and is based on the relationship between the shareholders or owners, described as the 'principals', and the managers of the organisation as described as ‘agents'. As such, in agency theory, corporate governance or organisational control is clearly divided from the contract between the ‘principal’ and ‘agent’ determined by financial remuneration (Eisenhardt, 1985). Jensen and Meckling (1976) advocated that managerial interests may not be aligned with the ‘principals’ but rather concerned with the maximisation of their own monetary rewards. Agency theory is based on an ‘economic’ model of man in which both the principal and agent is interested in their own financial gain. Davis, Schoorman and Donaldson

(1997:27) stated that, 'According to agency theory, man is rooted in economic rationality’.

Agency theory has a narrow focus reliant on the examination of shareholder returns and management control (Allen and Gale, 2000), and presents only a partial view of the world

(Eisenhardt, 1989). Stiles and Taylor (2002:130) claimed that agency and economic theory has dominated empirical studies on corporate governance, with the emphasis of research on the 'link between Board composition and financial performance'. Ryan (1994) advocated that agency theory’s economic focus is limited and devoid of a sociological perspective, particularly in relation to studies in healthcare. According to Stiles and Taylor agency theory:

…highlights the role of the Board as a monitor of management activities in order to minimise agency costs and thereby protect shareholder interests…It is clear that reducing agency costs and maximising shareholder wealth are key roles of the Board according to the theory (2002:14).

Hence, it may appear that agency theory is limited to governance research in private sector industries with shareholders. However, the micro-economic reform of the Victorian public sector introduced by the Liberal Government revealed an agency orientation via the

adoption of public organisations administered and governed by contracts. Placed within a public sector context:

Agency theory conceives of social relationships as ones between principals on the one hand and agents on the other. The principal specifies what is required, and engages and pays or otherwise rewards an agent to produce it. Thus, a principal– agent relationship can exist between a buyer and a seller, between an employer and employee, between voters and politicians and public servants … it is assumed in each case that people maximise their self-interest and therefore that principals and agents have conflicting interests (Alford and O’Neil, 1994:15).

This raises numerous issues for those in governance roles in the public sector in relation to the ‘maximisation of self-interest’. Muetzelfeldt (1994) described the notion of self- interest as ‘misplaced’ within a public sector context that is founded on the promotion of common or communal interest and ‘the common good’.

This thesis acknowledges that the impact of neo-liberalism on Victorian public sector agencies has seen some dramatic changes and an emphasis on organisational productivity, efficiency and economic success that has created pressures and dilemmas for governing bodies. Such dilemmas may include the reduction in staff to meet the bottom line and in the case of a public health service, possible services reductions or reconfigurations. The study seeks to examine how those in governing roles are best able to meet the economic goals and the social needs of their stakeholders. The thesis argues that in both the private and public sectors, the social or human elements of governance are as important as the economic or business imperatives of the organisation and they should not be understated or ignored (McGregor, 2000; Garrat, 2003). As stated by Tricker:

Critics of agency theory argue that the reality of governance involves interpersonal and political relationships that are just not reflected in a two-person contract (2000:xxii).

Given the context of the setting of this study, a large public health provider, agency theory was not considered as the most appropriate given that a public sector entity is not privately owned and accountable to shareholders, despite the push for agency principles via the creation of the ‘Contract State’ (Alford and O’Neil, 1994). HealthCo can be described as an organisational melange of both traditional and contractual arrangements and

accountable to its ‘principal owners’ that include the community and the government. The rationale posited by Cornforth best accounts for inappropriateness of agency theory for this study:

One difficulty in applying an agency perspective to public and non-profit

organisations is that there is much more potential ambiguity over who the principal owners are…in the case of public organisations, it is the general public, service users, taxpayers or the government itself (2003:7).

A discussion of the other major theoretical perspectives on governance is now presented.