Agency Theory

Agency theory and principal diagram

The Agency theory suggests that an organisation can be seen as agreements between resource holders.   An agency relationship arises whenever one or more individuals, called principals, hire one or more other individuals, called agents, to perform some service and then delegate decision-making authority to the agents.

Two of the primary agency relationships in a commercial organisation are between (1) shareholders and managers and (2) between employers and employees.  These relationships are not necessarily positive; and agency theory deals with these agency conflicts, or conflicts of interest between agents and principals.

This has implications for, among other things, corporate governance and business ethics. When agency exists, agency costs are also incurred, for example offering management performance rewards to encourage managers to act in the best interest of shareholders’.