Agency Theory

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DEFINITION of 'Agency Theory'

A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving problems that can exist in agency relationships; that is, between principals (such as shareholders) and agents of the principals (for example, company executives). The two problems that agency theory addresses are: 1.) the problems that arise when the desires or goals of the principal and agent are in conflict, and the principal is unable to verify (because it difficult and/or expensive to do so) what the agent is actually doing; and 2.) the problems that arise when the principal and agent have different attitudes towards risk. Because of different risk tolerances, the principal and agent may each be inclined to take different actions.

BREAKING DOWN 'Agency Theory'

An agency, in general terms, is the relationship between two parties, where one is a principal and the other is an agent who represents the principal in transactions with a third party. Agency relationships occur when the principals hire the agent to perform a service on the principals' behalf. Principals commonly delegate decision-making authority to the agents. Agency problems can arise because of inefficiencies and incomplete information. In finance, two important agency relationships are those between stockholders and managers, and stockholders and creditors.

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RELATED FAQS
  1. How is the principle agent problem manifested in the government?

    The principal-agent problem describes challenges that occur when agents and principals have conflicting interests. Democratically ... Read Full Answer >>
  2. How does agency theory propose to deal with the agency problem?

    Agency theory highlights potential problems that may occur when agents and principals have different interests. Principals ... Read Full Answer >>
  3. What are some famous scandals that demonstrate the agency problem?

    The agency problem occurs when agents do not appropriately represent the best interests of principals. Principals hire agents ... Read Full Answer >>
  4. Do employers use agency theory in labor relations?

    Agency theory is used in business relations to describe the potential problems that occur whenever the agent's interests ... Read Full Answer >>
  5. Does agency theory apply to brokers and clients?

    Agency theory describes the challenges arising from the different interests of agents and principals. Principals employ agents ... Read Full Answer >>
  6. What is the role of agency theory in corporate governance?

    Agency theory is used to understand the relationships between agents and principals. The agent represents the principal in ... Read Full Answer >>
  7. How do stockholders use agency theory to affect management?

    Stockholders use the principles of agency theory to affect the management of an organization by steering decisions based ... Read Full Answer >>
  8. What's the difference between agency theory and stakeholder theory?

    Agency theory and stakeholder theory are both used to understand and explain various types of relationships in business. ... Read Full Answer >>
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