When Bob Iger was initially hired as the CEO of the Walt Disney Company in 2005, the decision was likely based on a track record of success at the company. An assessment of his professional accomplishments indicated to Disney’s board of directors that he had the ability to lead the company. By the time he retired in 2021, the relationship between Iger and Disney’s board of directors had deepened so much that they invited him back in 2022 to develop a strategic direction for the company and to find and develop his successor. After years of service, the board trusted Iger to set the company up for success.
This is an example of the principal-agent relationship that is created when one person (the principal) gives permission to another (the agent) to act on their behalf. A common form of this relationship is between directors of boards and CEOs. Decision-making is delegated to and implemented by the CEO while decision oversight is borne primarily by the board of directors.
New and developing research complicates the notion of transactional relationships by acknowledging the emotion involved in all human interaction. In “Toward an Affect Based View of Principal-Agent Dynamics,” University of Arkansas Professor Jon Johnson, and Associate Dean Alan Ellstrand, along with Jacqueline Tilton and Hansin Bilgili take this approach. They dive into how affect and emotion, specifically trust, play a role in the principal-agent relationship.
Agency Theory Shift: from Contract to Feeling
Much scholarly work on principal-agent relationships focuses on agency theory, which focuses on economic behaviors in firms. In short, it asserts that corporations are a collection of contracts between different parties. While this theory is informative and useful in many respects, it leaves out how emotions can also play a part in corporate relationships.
Relational affect, however, is used largely in other governance theories. Relational affect denotes a set of moods and emotions an individual experiences in social interactions. Since emotion shapes human cognition, motivation, and behavior, relational affect can explain relationship dynamics in CEO-board relationships. As emotion builds in a relationship, the closer the relationship comes to exhibiting qualities such as loyalty, trust, and commitment.
A contract between principals and agents lists the responsibilities and expectations of each party. The principal can utilize the contract to generate incentives so the agent will act in the principal’s best interest. On the other side, building a relationship reduces the need for formal contracts or monitoring techniques. The researchers argue that trust, commitment, and loyalty deepen as the relationship progresses. They start on one end, a strict cognitive perspective, and extend to the other end of emotions as the relationship matures into something deeper.
Trust in the Relationship
Whether trust is developed immediately or over time can depend on institutional cues that signal trustworthiness and the individual’s disposition to trust. In corporate relations, principal-agent relationships are usually formed when a director is elected to the board, or a new CEO is hired by the board. Either way, judgements about qualifications have been made prior to the election or hiring decision, meaning that principals and agents usually begin their relationships with a baseline of trust. As relationships build and mature on that baseline of trust, emotions have a greater opportunity to influence the nature of trust within the relationship.
Prior research has identified two distinct forms of interpersonal trust, cognition- and affect-based trust. Cognitive trust is based on a calculated cost-benefit analysis. It is a judgement made after evaluating someone’s competence and reliability. Affect-based trust is built over time as the principal and agent interact and build a rapport. This type of trust is built on emotions, understanding, care and concern, and the belief in the intrinsic value of such relationships.
As cognition-based trust evolves an affective or emotional dimension, outcomes can evolve as well. For example, affect-based trust has been shown to increase cooperation. The underlying idea is that when emotions are not present, trust lacks a critical motivational element. In this way, trust without emotion reflects the traditional tenets of agency theory that assumes external incentives are needed to control an actor’s self-interest.
Negative emotion reduces trust. Anger, fear, and frustration are all examples of negative emotions that will likely diminish someone’s trust and lead to undesirable behaviors such as deception, avoidance, and unwillingness to share information. However, it is more likely for principals and agents to experience positive emotions based on two antecedents. First, the level of organizational citizenship behavior (voluntary acts outside of an employee's formal duties) and second, the frequency of informal interaction. Affect-based trust can facilitate open communication and the exploration of new ideas which can promote creativity and innovation.
For CEOs and directors engaging in positive emotional interactions, one of the key outcomes is strengthening high emotional relational dimensions, but that relationship strength could come at a cost. Embedded in the relationship is a subsequent motivation to preserve the resources that sometimes can result in prioritizing the relationship itself over organizational performance. Principals and agents may act in ways that preserve the emotion such as increasing cooperation and avoiding necessary conflict, but these moves to preserve the relationship could contradict organizational strategies.
Highly emotional relationships also increase the possibility of ingenuity from agents. In corporate governance, CEOs seek to build social capital via attempts such as impression management to create emotional bonds with directors. These attempts can be in the form of flattery, favor, rendering, and opinion conformity. One director recalled, “I told him he made the right [strategic] move at that company. He had gotten some criticism for that strategy, and I was basically saying ‘Hey, don’t worry about the critics’, you did the right thing.”
Executives who engage in these behaviors can thus enhance their social capital by obtaining important positions. Therefore, principals with strong emotional relationships with their agents may be vulnerable to manipulation and additional agency costs such as compensation increases and corporate diversification.
The affect-based view on principal-agent relationships moves agency theory from a strictly transactional theory to a socially informed and behaviorally oriented theory. However, emotion is both a relational and an intrapersonal process and therefore future research should explore how intrapersonal emotions influences principals’ and agents’ cognition, motivation, and behaviors. For example, further research could explore how moods and situational emotions can influence principals’ and agents’ communication, decision making, and overall relationships.
By recognizing emotion in principal-agent relationships, the researchers further humanize the relationship and highlight the importance of trust, one of the relationship’s key dimensions. Without this consideration, scholars and theorists miss an important piece in understanding and predicting behaviors of leaders and directors. A better understanding of emotion can prepare boards to capitalize on the benefits such as improved information and resource sharing while alleviating agency costs.
