Agency theory and its consequences: A study of the unintended effect of agency theory on risk and morality

Thomas Rüdiger Smith

Student thesis: Master thesis


The failing corporate governance system, excessive risk-taking and the greedy manager have all been cited as reasons for the recent financial crisis. This thesis determines the connection between these three aspects and agency theory, deriving two potential side effects and consequences. In theoretical support of the relationship between the shareholder primacy inherent in agency theory and risk-taking as well as the critique of the model of man in agency theory, two intertwined research questions are investigated, Did the agency theoretical prescriptions of corporate governance and directors’ financial literacy impact the risk profile of Scandinavian banks during the Financial Crisis? And are there differences in the moral and ethical perceptions of business majors in comparison to other majors? Through an analysis of agency theory and its impact on practical corporate governance, this thesis develops ten hypotheses regarding the relationship between risk-taking to the composition of board of directors, director background and the utilization of stock based remuneration. Additionally, based on the critique of agency theory, three hypotheses with regards to the presumed negative impact of agency theory on the moral and ethical perceptions of business majors are presented. The data from Scandinavian bank boards and risk measures shows that some of the agency theory prescriptions may lead to increased risk-taking. Moreover, it finds that the financial literacy of directors leads to a higher proclivity to utilize these prescriptions and therein also higher risk-taking, however the verdict on concrete side effects of agency theory is not unequivocal. Through a questionnaire on ethical perceptions, this thesis further finds that there is no difference in the perceptions of business majors vs. other majors, but rather that there is a difference in the ability to follow through on their ethical or moral convictions. Business majors thus appear to be more willing to carry out a given action despite these convictions. The discussion of these results as a whole argues that a more critical approach to management education is needed in order to question the consequences, side effects and assumptions of agency theory and the ethos associated therewith. Herein both the introduction of alternative theories of governance and an integration of business ethics, particularly of virtue theory, is perceived to provide a relevant framework for assessing courses of action and enabling a more holistic and informed approach to decision making. Consequentially, such enhanced critical inquiry may aid in questioning those prevailing best practices and norms that may not actually be in the interest of society nor ethically correct.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2011
Number of pages133