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Agency Theory

A theory that explains the relationship between principals and agents in business (In this relationship, the principal hires an agent to do the work, or to perform a task the principal is unable or unwilling to do. For example, in corporations, the principals are the shareholders of a company, delegating to the agent i.e. the management of the company, to perform tasks on their behalf.) 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.
Since the late 1700s, theorists have discussed the problem of corporate owners hiring others as stewards of their wealth. Managers of other people’s money cannot be expected to watch over it with the same zeal as the owner, so managerial negligence will always be present in the affairs of a company (Smith, 1776/1952).
According to agency theory, an agent or agency is hired by one or more person(s), called the principal(s), under a contract and is compensated by the principal to achieve desired outcomes for the principal. Because the agent is acting on behalf of the principal, the principal gives away some decision-making authority to the agent.
Agency relationships occur in a wide variety of situations and contexts that involve the delegation of authority— Investment Banks act as agents for their clients. Too often there are conflicts of interest in these agency relationship. for

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