Agency Theory

According to the principle of hedonism, almost all individuals act in accordance with self-interest by exerting minimum effort to extract maximum benefits. It is assumed that everyone is cognizant of the self-interest motivations of others, and this gives platform for concerns about conflict of interest. In the context of organizations, these conflicts are apparent between the principal who engages another individual called an agent, to perform services on his/her behalf. Agency theory explains the relationship between the principal (the shareholders) and the agent (the CEO)— who has been engaged to make decisions on the principal's behalf. Issues may develop because the principal and agent, while working toward the same goal, do not always share the same interests. The actions of agents (called CEOs and top management team) may not necessarily be consistent with the interests of principal (stakeholders). Strategic management therefore attempts to bring some governance mechanism through a board of directors to see that agents will not take decisions in their self-interest. The boards of directors will ensure that that the interests of both the principal and agents are aligned for the benefit of the organization. In this process some agency costs are involved, such as the principal's monitoring of expenditures and the agent's bonding cost. Agency theory also explains the reasons why agents will not be motivated to exert effort unless incentives are provided and some share in the value of the firm is negotiated by the agents in the contract. Agency theory ties pay closely to performance.

Resource-Based View (RBV)

According to Barney, sustained competitive advantage largely depends on the resources (assets, capabilities, organizational processes, firm attributes, information, and knowledge) a firm possesses. Although a firm's external environment is important, firm resources are far more important than the environment in which the company operates. RBV is based on two key assumptions, namely, resources are heterogeneously distributed across all the firms, and the firm resources are largely immobile. Given these assumptions, a firm secures competitive advantage if the resources possess the qualities of rarity, value, imperfect limitability, nonsubstitutability, and nontransferability. The proponents of RBV argue that competing firms will not be able to imitate strategies based on resources because there is causal ambiguity and social complexity associated with the relationship between these resource configurations and sustained competitive advantage. RBV has gained wide currency in the academic lexicon because its capability logic is very convincing in explaining why some firms achieve success despite the fact that they fall under the industry that is not performing well. The core logic behind the RBV is the "capability logic" that states that a firm can outperform rivals only if it has a superior ability to acquire, develop, configure, and use the resources to sustain its competitive advantage. The basic argument of the RBV is that a firm's competitiveness is a positive function of the resource mobilization and capability building so that strategies are designed to capitalize on the opportunities and mitigate threats stemming from the environment. The way in which firms exploit and leverage internal abilities and resources is the key. Having superior resources is a necessary, but not sufficient, condition. What is important is that the resources and competencies need to be protected from exploitation by competitors through imitation and substitution.

Industrial Organization (IO) Theory

According to IO theory, industry forces in which a firm operates are very important for the firm to maintain profitability. The industry attractiveness depends on the strength of the five forces: competition of firms within the industry, bargaining power of buyers, bargaining power of suppliers, threat of new entrants, and availability of substitute products. The stronger the forces, the more unattractive the industry becomes. Analysis of these five forces is the key for a firm to see whether it can have an edge over its competitors. IO theory places a premium on the environment and is explicitly concerned with the opportunities and threats stemming from the environment. Researchers who subscribe to the IO theory argue that a firm should scan the external environment and focus on identifying and exploiting opportunities and neutralizing threats. However, it is necessary to match the firm's internal capabilities to exploit opportunities and strengths, in order to mitigate the threats from environment. Strategic management researchers attempt to address the performance differences across firms in terms of two basic approaches: IO and resources. As Montgomery contends, a portion of these differences may be "due to unique firm characteristics and actions; and another portion is due to the conditions in their respective industries in which firms operate."5 Scholars argue that industry effects explain far more variance than firm effects. The debate is ongoing.

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