Which theory defines the relationship between shareholders and management while addressing potential conflicts of interest?

The concept that defines the relationship between shareholders and management while addressing potential conflicts of interest is known as the shareholder/agency theory. This theory posits that in a corporation, the shareholders (principals) delegate authority to management (agents) to run the company on their behalf. A central tenet of this theory is that there may be conflicts of interest between the goals of the shareholders and those of the management. For instance, management may prioritize personal interests or short-term gains over the long-term profitability that shareholders desire.

The agency theory also suggests mechanisms to mitigate these conflicts, including performance-based incentives for managers, strong governance structures, and active shareholder oversight. By addressing these potential conflicts, this theory emphasizes the need for alignment between the interests of shareholders and those of management to promote the efficiency and success of the organization.

In contrast, the other theories do not specifically focus on the shareholder-management dynamic. Stakeholder theory expands the focus to include all parties affected by corporate actions rather than just shareholders. Legitimacy theory concerns itself with the perception of the corporation's actions as socially acceptable. Institutional theory analyzes the broader social and cultural contexts that shape organizational behavior without focusing specifically on individual conflicts of interest. Therefore, the shareholder/agency theory is the most appropriate framework for