Agency theory

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The appropriate framework for understanding the contractual relationship, for instance, between a hotel operating company and a hotel owning company is agency theory (RodrÍguez, 2002). The agent is represented by the operating company, the principal is represented by the owning company, and the two parties' relationship is mediated by a hotel management contract. Agency theory explains how to best organize these relationships in which the owning company (the principal) delegates the work to the operating company (the agent) who performs that work. More specifically, the focus of the theory is on the contract between the principal and the agent and the ways in which the contract can be made most efficient from the point of view of the principal. In determining the most efficient contract, agency theory makes certain assumptions about people, organizations, and information. It assumes that agents and principals will act in their self-interest to maximize their own welfare, hence identifies two barriers to effective contractual performance: adverse selection and moral hazard (Fama & Jensen, 1983). Adverse selection is the condition under which the principal cannot ascertain if the agent accurately represents his ability to do the work for which he is being paid. Moral hazard is the condition under which the principal cannot be sure if the agent has put forth maximal effort.

Fama, E., & Jensen, M. (1983). Separation of ownership and control. Journal of Law and Economics, 26, 301 326.
RodrÍguez, A. R. (2002). Determining factors in entry choice for international expansion. The case of the Spanish hotel industry. Tourism Management, 23(6), 597 607.


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