University of the South Pacific

Name: Peldro Rooney

Course Code: MG214 – Principal of sector
management
ID: S11152110
ASSIGNMENT 1
 Discussing how the Transaction Cost Theory and Principal Agent Theory influencing
the New Public Sector Management Model.

In the modern world today it is significant to understand that every country relies on
economy to progress in terms of development. Public sector is simply referring to the
organizations that operated by the government, they are much similar to voluntary sector that
do not seek to generate profit. However, in the mid-19th century the introduction of the New
Public Sector Management Model creates a large transition. These changes that involved in
the new public sector are very significant to understand. The course MG214 provides the
opportunity to study and understand the principle of public sector management. This includes
the movement from Traditional to New Public Sector Management Model (NPM) and the
different theories that influence the NPM. Therefore, this essay seeks to discuss the links
between Transaction Cost theory and Principal Agent theory, and how both theories influence
the New Public Sector Management Model (NPM).

Transaction Cost Theory and Principle Agent Theory

Transaction cost is simply referring to the charges or fees incurred while buying goods and
services. Hence, according to the Business dictionary, Transaction Cost theory is a “theory
accounting for the actual cost of outsourcing production of products or services including
transaction costs, contracting costs, coordination costs, and search costs. For example, the
USP institution around the Pacific region have their fees or charges to be paid when student
enrolled this fees covers all costs stated by the theory. The inclusion of all costs are
considered when making a decision and not just the market prices. Essentially this theory
illustrates the make versus buy decision for companies”. This simply means that transaction
cost theory is based or build in assumptions of bound rationality and opportunism. Therefore,
it aims to provide solution for the question of when activities would take place in the market
and when it would take place within the firm. In other words, transaction cost theory assumes
and predicts when the governance form of hierarchy and markets will be used.

Another significant theory is Principal Agent Theory. When discussing principal-agent theory
it involves two ideas or parties. The principal at the principle-agent theory is simply referring
to the public. This is due to the fact that the public or especially the public workers are the
ones who pay tax to the government. A classic example to describe principal are Nurses,
teachers and other public servants in different countries around the Pacific. On the hand,
agent at the principal-agent theory refers to someone whom the authority is given to represent

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the others. The principal-agent model is often used by scholars to make significant decision
which determines when agents do (or do not) act in their principles interests. Therefore, by
definition, agent is someone who is selected for his/her specialized knowledge while the
principal is there to completely asses the agent’s performance. For example, in the Solomon
Islands there are different public sectors department such as the Ministry of Education and
Human Resources (MERHD), Ministry of Finance and Ministry of Lands etc. the managers
on those public sectors are agents.

The New Public Sector Management

As stated, during the period of 1980s and 1990s there was a public sector reform and this was
largely referred to as ‘New Public Sector Management’. It is used to describe the
economistic, managerial changes in the public management system. The new public sector
model attempts to make the public sector more like business. It also improved the
government management model borrowed from the private sector. Unlike the old public
sector, the new system strongly focused on financial control as well as improvement of the
economy. It also introduces audits at both financial and professional level and transparent
monitoring of performance.

Influence Both Theory had on the New Public Sector Management Model (NPM)

Transaction theory has a great influence in the New Public Management Model. As stated the
new model focus on financial control and seeks to build profit. Hence in order for this to
work transaction play very significant role in reducing the costs. Therefore, basically it is a
theory that influence very important decision making that enables firms and organisation in
the public sector.

Principal-agent theory also has great influence on new public sector management model. This
due to the fact that in order for the government to support its project and department to
function under the model it need the public support in a form of tax. To do this the
government assigned public sector manager as agents to act look at the public and made
important decision which a suitable for the public interest. Therefore, the principal agent
theory influences the model by protecting the interest of the public.

To sincerely conclude, it is significant to note that new public sector management model is
more businesslike. It was influences by several theories including transaction cost theory
which explains the charges incurred when buying goods and services. In addition, it is also

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explaining how this cost can be reduced. Also there is a principal-agent theory which is based
on the two parties the public and public sector managers. Most importantly both these
theories have very great influence on the new public sector management which we used in
our countries nowadays. Therefore, it is very important as individuals who live under the
system should understand the theories and their influences.

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 References
Dunleavy, P. and Hood, C., 1994. From old public administration to new public
management. Public money & management, 14(3), pp.9-16.
Laffont, J.J. and Martimort, D., 2009. The theory of incentives: the principal-agent model.
Princeton university press.
North, D.C., 1990. A transaction cost theory of politics. Journal of theoretical politics, 2(4),
pp.355-367.
Pearce, R.J., 1997. Toward understanding joint venture performance and survival: A bargaining and
influence approach to transaction cost theory. Academy of Management Review, 22(1), pp.203-225.

Schedler, K. and Proeller, I., 2003. New public management. New Public Management,
p.163.
Young-Ybarra, C. and Wiersema, M., 1999. Strategic flexibility in information technology
alliances: The influence of transaction cost economics and social exchange
theory. Organization science, 10(4), pp.439-459.