Agency Theory

Abstract

The theory of agency seeks to understand the problems created when one party, the agent, is acting for another, the principal. Agency has two sides: The activities and problems of identifying and providing services of “acting for” (agent side), and the activities and problems of guiding and correcting agent actions (the principal side). Because all actions and corrections have costs, it often does not pay the principal (or the agent) to insist on, or provide, perfect agency. But social institutions must routinely manage such imperfect conditions. By instructing the agent to perform as perfectly as possible for the principal, the fiduciary norm helps solve the institutional dilemmas of ensuring trustworthy behavior. The article describes the basic arguments of agency theory, its origins, and the varieties of work being done. The best known application of the theory of agency applied the economic theory of agency to the theory of the firm, though agency theory, including the more general institutional theory of agency, has applications throughout social science. The institutional theory of agency is not constrained by assumptions embedded in economic theory or to the modeling of the corporation alone.