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Agency Theory and Uncertainty in Organizations: An Evaluation

Department of Management, University of Canterbury, Christchurch, New Zealand

Hayagreeva Rao

Emory Business School, Emory University, Atlanta, U.S.A.

This paper evaluates agency theory as a theory of performance outcome. Agency theory attributes uncertainty in performance outcomes to moral hazard, adverse selection and the state of nature. This paper argues that by overlooking two critical sources of outcome uncertainty in organizations — incomplete knowledge about the effort-outcome relationship and lack of agreement about effort and outcome — the generalizability of the theory is strictly limited. Even in such settings where it is generalizable, principal-agent approaches to contract design are unrealistic to the extent that they presume that performance in organizations results exclusively from individual-contributor jobs, exagger ate the degree to which individuals are work-averse, and emphasize the quant ity of effort at the expense of the quality and type of effort. As a theory of performance, principal-agent approaches overstate the importance of opera tional effort and ignore the importance of facilitative effort such as team work.

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