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business. It focuses on the conflicts that can Fair value theory
arise when agents are expected to act in the This theory is an accounting principle which
best interests of principals but may have states that assets and liabilities should be
their own self-interests. By understanding recorded and reported at their current market
and applying Agency Theory, businesses value, rather than their historical cost. This
can better manage the principal-agent
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relationship, reducing conflicts of interest approach provides a more accurate and
and enhancing overall performance and timely reflection of a company’s financial
accountability. For example: Publicly listed position by considering current market
companies: Shareholders (principals) of a conditions. Applying Fair value theory,
company listed on the Dar es Salaam Stock companies ensure that their financial
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Exchange (DSE) appoint managers (agents) statements present a realistic view of their
to run the company. Managers might focus financial situation, which can be particularly
on short-term gains for bonuses, while useful for investors, creditors, and other
shareholders prefer long-term growth. To stakeholders in making informed decisions.
mitigate this, the company could offer stock For example: A real estate company owns
options to managers, aligning their interests several properties. Under Fair Value theory,
with long-term company performance. This these properties are periodically revalued
theory has the following key components: to reflect their current market prices. If the
Principal-agent relationship: Principals market value of a property increases due to
delegate authority to agents to manage the urban development, the company records
company. the higher value in its financial statements,
providing a more accurate depiction of
Agency problems: Conflicts that occur its financial position. This theory has the
when agents prioritise their own interests following key components:
over those of the principals.
Current market value: Fair value is the
Information asymmetry: Agents often have price at which an asset could be sold, or a
more information about the business than liability settled, between knowledgeable,
the principals, which can lead to potential willing parties in an arm’s length transaction.
misuse.
Relevance: Provides financial statement
Moral hazard: The risk that agents may users with relevant and up-to-date
engage in behaviours that are not in the information about the true economic value
best interest of the principals due to a lack of a company’s assets and liabilities.
of oversight.
Measurement: Fair value can be measured
Adverse selection: The difficulty principals using various methods, such as market
face in accurately assessing the agents’ prices, comparable sales, or discounted
capabilities or intentions at the time of cash flows, depending on the availability
hiring. of observable inputs.

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