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ABSTRACT. This paper evaluates the current use of the Principal Agent Model (PAM) in accounting and finance, focusing on the agent's use of private information. The agent's behavioral norms in the the PAM deviate from commonly held ethical values in society, from models of man in conventional economic theory, and also from behavioral foundations of related business school fields like corporate strategy, business ethics, and human resource management. Still, it would be unwise to reject the PAM solely because of its distasteful ethical assumptions. The model does appear to have predictive power, but its descriptive or normative qualities remain unexplored. The popularity of the PAM, with its extreme model of man, raises fundamental questions about the impact of this model on business school stakeholders and society at large.
The principal-agent model (PAM) of Jensen and Meckling (1976) clarifies, extends, and formalizes earlier ideas on conflicts of interest between organizational stakeholders and the mechanisms for solving such conflicts.' The paper initiated an active and increasingly influential research program, and it was soon predicted that due to agency-based research, "the foundations are being put into place for a revolution in the science of organizations" (Jensen, 1983, p. 319).
Just four years after this prediction, Ross (1987) called agency theory the central approach to the theory of managerial behavior. Today, the PAM is widely used in economic disciplines like accounting, micro-economics, and finance. The principal-agent framework has also entered marketing (Bergen et al., 1992) and non-economic social sciences like sociology, organizational behavior, and political science (Eisenhardt, 1989).
Despite the widespread adoption of the principal-agent approach in the social sciences, there have been rather few attempts at evaluating the PAM from a methodological point of view. Kaen et al. (1988) relate the intellectual roots of agency theory to political ideologies in the U.S. Walker (1989) finds that regardless of application area, most versions of the PAM will be hard to falsify, mainly because the validity of required auxiliary hypotheses cannot be checked. Comparing the model to competing theories in sociology and organizational behavior, Perrow (1986) is highly skeptical, primarily because the PAM ignores the cooperative aspects of social life. Brennan (1994), who argues strongly against including self-interest in the definition of rationality in economic theory, criticizes the PAM...