Agency theory is one of the most important concepts of the business areas especially financial economics. Because of its importance, this theory is included in most of the introductory chapters of the modern financial economics books and publications. It is commonly cited as one of the key areas for progress and improvement of the modern financial economics. Moreover, its assumptions provide wide explanations for crucial business areas such as: merger activities, dividend policies, capital structure, corporate restructuring, and executive compensations, etc…

Agency theory defines the company or the firm as “nexus of contracts” between different resource suppliers. It is centralized on two different parties: principal, who supply the capital, and the agent who manage the day to day operations for the firm. In other words, it is the relation between one who determines the work and another who does the work. For example, in corporations, principals are the shareholders who delegates work to the agent which is the manager in the company. Agency theory assumes that shareholders and managers are motivated by their self –interest, thus managers are likely to persist their self-interest goal that contradicts with the goals of the owner. However, agents are supposed to work for the self-interest of the principal. This conflict results with a cost called the agency cost. This cost represents the cost of supervising the behavior of the agents as well as the profit loss resulting from operating policies and restrictions on management. Although the agency theory is controversial and contradictory, many scientist talked about this concept and explained its advantages and disadvantages on many business fields’ especially financial economics.

Many scientist and scholars talked about the agency theory, and it is one of the most crucial theory in the economic and financial history fields. This theory was originated and created by two scholars, Stephen Ross and Barry Mitnick. Each one had a take a part of the agency theory and created. Economic wise, Stepeh Ross is the one responsible for the economic theory of agency, and financial wise, Barry Mitnick is responsible for the institutional theory of agency. These two scholars used the same concepts but under different assumption. Everyone introduced the theory in his own way or thinking. Ross introduces the agency theory from the side of problems of compensation relation and as an incentive problem. On the other side, Mitnick introduced how the institutions should evolve to deal with deficiencies that is created by the agency relationships. According to Mitnick, “Behavior never occurs as it is preferred by the principal because it does not pay to make it perfect.” This is the main problem that Mitnick suggest as a deficiency of the agency relationship and he suggested that the society created rules and policies that help the companies to attend these imperfections, managing to deal with them, and adapting to them. Therefore, in order to understand the agency, people need both sides to see the incentive side as well as the organizational structure. However, this theory did not accurately defined properly and introduced to the world until the initiation of Jensen and Meckling articles in 1976. Jensen and Meckling introduces the agency theory as a relationship problem that arises between the owner of the resources and the one who is managing those resources. More general speaking, a conflict can arise between one who owns the capital and the one who is controlling the day to day operation since every party has his own interest that wants to be achieved and those interests can be contradictory. According to Jensen and Meckling, “Agency cost arise from the conflict of interest between a principal and an agent.” For example, when managers, who are responsible for decisions that impact the operation of the firm, are not the primary beneficiary of the firm net assets, and do not accept any effect regarding his or her decisions. Moreover, the agency cost is divided into three type of cost: structuring cost, monitoring cost, and bonding cost. Structuring cost is the cost that a firm should take it when manufacturing any product or service such as transaction cost, suck cost, and fixed cost. It is the fixed cost divided by the variable cos