Agency Theory: Relationships of Principals & Agents

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: AMO Theory: Ability, Motivation & Opportunities

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 0:03 What Is Agency Theory?
  • 1:26 History and Characteristics
  • 2:33 Self-Interested Behavior
  • 3:45 Difference in Attitude
  • 4:59 Case Study
  • 5:42 Lesson Summary
Save Save Save

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Timeline
Autoplay
Autoplay
Speed Speed

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Savannah Samoszuk

Savannah has over eight years of hotel management experience and has a master's degree in leadership.

Have you ever hired someone to take care of something you did not have time to do? This is an example of agency theory. This lesson explains the concept of agency, agency theory, the history and characteristics of agency theory, and the common problems with agency relationships.

What Is Agency Theory?

Jim uses a financial advisor to take care of his investing and savings accounts because he does not have time to manage his finances. Jim's advisor acts and makes decisions on Jim's behalf when it comes to his finances. While Jim gives the financial advisor permission to make decisions, the two of them may have different mindsets when it comes to risk, and they may both have different ideas about what kind of gain is the best. This is a great example of agency theory.

Agency relationships exist between principals and agents. Principals are people in positions of authority in a business, whereas agents are people who handle business for others. For example, in the earlier example, Jim is the principal and he hires the advisor as his agent. In this case, Jim is higher in authority because he is employing the financial advisor to take care of his finances for him.

Agency theory is the explanation of the dynamics that occur in these relationships and especially offers an explanation for what happens when there is a problem or conflict in goals that arises between the principal and the agent. The difference in opinion when it comes to risk between Jim and his financial advisor can cause conflict just like that explained by agency theory. This lesson will discuss the characteristics of agency theory, problems with agency theory, and provide a more detailed example of agency theory.

History & Characteristics

Agency theory formally came about in the 1970s, but its concepts have been seen throughout history. For example, for as long as people have done business with one another, the core components of agency theory and the types of conflicts it explains have existed. When farms first started selling their food to grocery stores, it created an agency relationship. When people started organizing financial life into institutions like banks and investment firms, this also created a new type of principal-agent relationship. Agency theory exists when an agency relationship is formed and conflicts or differences in opinion can arise in this relationship.

Agency theory looks at the problems that can arise in any kind of agency relationship with principals and agents. Another example of an agency relationship is that of the relationship between stockholders and the CEO of a company. The stockholder is the principal who effectively hires the CEO to make decisions on their behalf. The core problems that can arise in this relationship are self-interested behavior and difference in attitude in regards to business decisions.

Self-Interested Behavior

When you are trusting someone to handle your finances or business affairs, there can be conflict when it comes to self-interested behavior, or the agent putting his or her own interests before those of the principal. If the agent you hired to run your company or handle your finances only cares about their own self-interest, it can cause problems for you as the person who hired them. Agency theory examines this conflict between these principals and agents.

For example, if Jim's financial advisor is only looking to grow his own bank account, he will not have Jim's best interest in mind, and this is an example of self-interested behavior. Perhaps he will sell an expensive investment package that offers a good bonus or commission, but it will actually result in worse financial outcomes for Jim. This is a classic example of self-interested behavior. In the example of the CEO and stockholders' relationship, the CEO may have his own interest (perhaps making decisions that benefit the CEO's position more than the company's bottom line) in mind when making decisions for the business. This type of self-interested action can occur in nearly all principal-agent relationships.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create an account
Support