The Importance Of Agency Theory In Nonprofit Organizations

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Agency theory is one of the dominant theories to explain the characteristic and role of board. Earlier, agency theory was developed to explain the dynamics between employees and employers under contractual relationship for providing certain services (Jensen & Meckling, 1976). Scholars rely on behavioral assumptions that people are normally rational and self-interested (Jensen & Meckling, 1976). However, there could be a certain degree of informational asymmetric between groups, and it can cause the agent not to act in the best interest of the principal (Eisenhardt, 1989). Olson (2000) exemplified an agency relationship with “the association between owners and managers in a corporation.” When the owners become assured of the success of a certain …show more content…
But the fact that we need to remember is that nonprofit organizations has no dominant ownership. Therefore effective resource utilization has to be guaranteed to not only sustain their business but also to be successful as nonprofit organizations in the field (Fama & Jensen, 1983), and Fama and Jensen (1983) suggest monitoring the agent as one of major board roles in nonprofit organizations. Usually in nonprofit organizations, we consider the agent is executive director of the organization and the principal is the board member. As it mentioned with assumptions above, the agent, executive director in the nonprofit organizations, is just like other people, who chase their own interests and benefit, so that someone should monitor the agent to prevent situations of moral hazard, and someone is the principal, the board members (Napoli, 2012). For agency theory to explain the monitoring role of the board, there are three essential requirement (Miller, 2002, p. 434); “the board must recognize the chief executive’s potential for self-interested behavior,” “members of the board must agree as to whom the organizations is accountable,” “the board must understand the full range of programs and services that the organization officers, as well as the relative contribution of each toward achieving the …show more content…
However, it is not surprising to see some kind of embezzlement or misuse of resources from nonprofit organizations, such as a recent incident, “Madison nonprofit leaders rip city officials over employment program funding process.” Accordingly, it is very crucial for the nonprofit board to separate the function of monitoring process and implementation, so the goals of nonprofit organization cannot be compromised while they contribute their true effort to social

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