Lecture 4

MDS-506:
Governance Theories: Agency Theory
Power,
Politics and
Governance Nurul Huda Sakib
PhD (The University of Sydney)
Associate Professor
Department of Government and Politics
Jahangirnagar University
Mobile: +8801889733737
ORCID ID: https://orcid.org/my-orcid
News on Governance, Power and Politics
• You can share (Bangladesh context) news related to:

-About the government’s policy against COVID-19 management

-Institutional Strengthening
-Governance Problem
-Achievement to Improve Governance
 Discuss the following two news in the breakout room and relate
your thought based on previous classes. To what extent you
believe that these are related to our course and learning
materials?
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Principal-Agent Relationship
• This principal-agent model is a useful topic economic and other social science areas to
define and analyzing governance and corruption.
• In simple situations, economists have examined how the principal should pay and
punish the agent (Shavell, 1979) and what will be the strategy to gather information
from the agent (Gjesdal, 1982).
• It indicates the problem of how person A (the principal) can motivate person B (the
agent) to act for A's benefit and not focusing self-interest.
• Jensen and Meckling defined: “A contract under which one or more persons (the
principal(s) engage another person (the agent) to perform some service on their behalf
which involves delegating some decision-making authority to the agent.” (1976, p.308)
• This contract may be simply constituted implicit terms about how the principal expects
the mangers to behave (Deegan 2009).
• The principal, A, may be an employer and the agent, B, an employee, or the principal
may be a shareholder and the agent a director of a company (Black, 2009).
• But the principal can prescribe the payoff rules in their relationship. Furthermore,
decisions are considered to be trade-offs between different kinds of costs (monitoring Figure: The Principal-Agent Relationship
costs, bonding costs and residual loss).
Assumption of Principal-Agent Theory

• Assumptions Of AT are: • Information Asymmetry:

-Bounded rationality (Manager's Information available to the insiders
supremacy) (managers) are not the same available
-Opportunism public or outsiders (stakeholders) (Scott
-Information asymmetry 2009). Asymmetry of information does
not allow the principals to be sure whether
-Conflict of Interest the agents are carrying out the duties that
• AT assumes that the interests of principles they should according to the contract
and agents diverge (Hill, Charles and (Shapiro 2005). Contract does not have to
Jones 1992) be written contract. That is, it may be
• Both parties intends to promote their own simply constitute implicit terms about
self-interest (Kunz, Alexis and Pfaff, how the principal expects the mangers to
2002) behave (Deegan 2009)
 • The principal-agent relation may accumulate at many levels. Anybody could
become principal in terms of the context of the given situation.

• As Ackerman stated, “pathologies in the agency-principal relation are at the

heart of the corrupt transaction”, where principals can be “bureaucratic
Principal- superiors, politically appointed ministers, or multiple principals such as the
general public” (Rose-Ackerman, 2007).

Agent • Similarly, Morgan stated that, “the principal is the shareholder while the
agent is the strategic decision-making unit within the firm”(Morgan &
Relationship Strong, 2003).

in • For example, a constitution can be analyzed as an agency by which people

delegate to constitute public institutions the right and duty to undertake

Governance
some given tasks.

• Thus the primary principal is the people, and the ruler is the primary
agent” (Josselin & Marciano, 2004). In the second level, the ruler is the
principal, and the executives are his agents. It could be a continuous
process that might form many steps.
Robert Klitgaard’s Model of Agency
Relationship
• Klitgaard is famous for developing the formula for corrupt
systems:  C = M + D – A.  Meaning corruption equals
monopoly plus discretion minus accountability.  If a system
gives an official monopoly power over a good or service,
the discretion to decide how much a particular client
receives, and is not accountable, then the system will be
prone to extortion or bribery.  
• Klitgaard also analyzes corruption by using the principal-
agent-client model.
• He defines that, a principal employs an agent for a https://www.cgu.edu/p
particular task and the agent interacts with the client on eople/robert-klitgaard/
behalf of the principal.
• An agent will be corrupt when in her judgment her likely
benefits from doing so outweigh the possible costs.
• Similarly, a client will engage in bribery or other forms of
illicit behavior when the benefits to him outweigh the costs
to him(R. Klitgaard, 1988).
Robert Klitgaard’s Model of Agency Relationship

• During this process, the agent has two choices:

Agent's Decision
1. Not to be corrupt: In that case the agent will receive his/her regular Tree
pay and moral satisfaction of not being a corrupt person. Most
importantly he will work in favor of the principal.
Be Corrupt Do Not Be Corrupt
2. To be corrupt: When he/she becomes corrupt, he/she gets a bribe.
Being a corrupt he or she might also suffer morally which totally depends
on his/her own ethical, cultural and religious standards. Some other facts, Caught Not Caught
such as what his/ her peers and colleagues are doing, how big a bribe
he/she gets for how large a deviation from his/her responsibilities to the
principal. While corrupting, he/she might catch and penalize. It could be
Figure: Agent’s Decision Tree
an even worse situation for him/her by losing pay, job, a criminal penalty,
Source: Klitgaard, R. (1988). Controlling Corruption.
and a disgrace to his / her name and so on. California: University of California Press.
Robert Klitgaard’s Model of Agency
Relationship
• Thus selecting an agent is crucial in terms of his desire services to combat corruption. Because,
the corrupted agent will receive private benefit but generates costs or ‘negative externalities’
for the principal (R. Klitgaard, 1988).

• Therefore, the principal carefully select the agent and monitor him all the way. He will try to
get all the information about him persuades the agent to act on his desire.

• This model became difficult in the public sector when he has poor information about the
agent’s activities either productive or corrupt.

• Because it is very difficult to say whether the agent is manipulated by someone or corrupt and
took incentives not to work in favor of the principal. The agent knows what he/she is doing,
but the principal can’t believe what she says. The agent will try to mislead the principal making
him understand that he/she is working in favor of him and not corrupted.  
Robert Klitgaard’s Model of Agency
Relationship
• On principal perspective, this is called asymmetry
information.

• He has to set the agent’s pay and penalties without perfect

knowledge of the agent’s marginal productivity and
externality-generating behavior. So, he will try to set up
systems for gathering information about the agencies
activities, which will be costly one (R. Klitgaard, 1988).

• The Same relationship could draw in between principal and

client and the result would the same.

•Illicit behavior flourishes when agents have monopoly

power over clients (clients will be most willing to pay bribes when
they reap monopoly rents from service provided by the agents),
when agents have great discretion, and when the accountability
of agents to the principal is weak (R. Klitgaard, 1988).

• So, from the policy perspective there is a need for

alternative approaches to fighting against corruption. Klitgaard
divided it into five clusters:
 Question for Discussion

• Do you think Robert Klitgaard’s agency model is more

developed country phenomena? Why or why not?
• Do you think suggested anti-corruption alternative
approaches are fruitful in the context of Bangladesh? Why
or why not?
• What do you suggest to reduce information asymmetry?