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Agency Theory

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PPGPortal > Home > Concept Dictionary > A > Agency Theory
 
Agency Theory (Principal-Agent Problem) 

A problem that often exists when one person is acting on behalf of another that is created by the reality that the goals of the agent can differ from those of the principal, and it can be difficult for the principal to verify what the agent is doing.

(York University, Theories Used in Research: Agency Theory, http://www.istheory.yorku.ca/agencytheory.htm.)

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Agency theory is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Examples include relationships between employer and employee, and between minister and public servant. Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principle to verify what the agent is actually doing.

The problem here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes towards risk. The problem here is that the principle and the agent may prefer different actions because of the different risk preferences. Consequently, ideal principal-agent relationships should reflect efficient organization of information and risk-bearing costs to best avoid these problems.

References

Eisenhardt, M, K. (1989). “Agency theory: An assessment and review.” Academy of Management, The Academy of Management Review, 14(1), pp. 57.

 

     

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