Topic: Agency Theory

Agency Theory describes the common problem of aligning interests of Principals and Agents.  Principals are typically represented as the the ownership of a firm (shareholders, partners, proprietors) and Agents are the providers of effort in a firm and can represent everything from a CEO down to the lowest level employee.  The factor which determines who the agent is has nothing to do with station, but rather of identifying who the relevant “player” is that will provide the effort that the principal is interested in.  Agency Theory deals with the modes and hazards of incentivizing and  monitoring effort.  The goal of the principal is to create incentives which motivate the agent to deliver the desired effort, at the least cost, while disincenting opportunistic or counterproductive behaviors and minimizing the need to monitor the efforts of the agent.  (Is that all???)


Wikipedia defines this as, “the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent.”

From the Invetopedia: 

What Does Agency Theory Mean?
A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company’s managers).
Investopedia explains Agency Theory
For example, an agency problem exists when management and stockholders have conflicting ideas on how the company should be run.
Agency theory is a very academic term. Essentially it involves the costs of resolving conflicts between the principals and agents and aligning interests of the two groups.
What Does Agency Problem Mean?
A conflict of interest arising between creditors, shareholders and management because of differing goals.
Investopedia explains Agency Problem

Principal-Agent diagram from Wikipedia











This diagram displays a simple representation of the agency problem.  The principal hires the agent to provide effort.  The principal and agent have divergent self interests which lead to differing motivating factors.  This leads the principal to create incentives to help align the agent’s interests with their own.  I’d add a second loop from the Principal to the Agent to signify monitoring which takes the place of hiring ex post.


More to come on this topic…


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