Agency relationship economics and history

Principal–agent problem - Wikipedia

agency relationship economics and history

The agency problem is a conflict of interest where one party, who is naturally The agency problem does not exist without a relationship between a principal Historical Example of the Agency Problem Markets & Economy. The principal–agent problem, in political science and economics occurs when one person or Common examples of this relationship include corporate management (agent) and shareholders (principal), Views. Read · Edit · View history. Request PDF on ResearchGate | The Economics of Organization: The Principal- Agent Relationship | The abstract for this document is available on CSA Illumina.

While consistent with the concept of agency traditionally advanced by legal scholars and attorneys, the economic variants of agency theory emphasize the costs and benefits of the principal-agent relationship. Ongoing analyses of agency costs are a common managerial tool, especially in corporations that are managed by nonowners, because they serve to indicate whether—or how well—a manager agent is fulfilling his fiduciary obligation to an owner principal.

Jensen and management theorist William H. Building on earlier work by the American economists Ronald CoaseArmen Alchianand Harold Demsetz, Jensen and Meckling developed an economic model specifically designed to capture the essence of the principal-agent relationship.

agency relationship economics and history

Consistent with the legal understanding of agency, Jensen and Meckling described the agency relationship as a contract explicit or implied in which one person, the principal, hires a second person, the agent, to perform some action. In such cases the principal formally delegates decision-making authority to the chosen agent. Jensen and Meckling began by assuming that each party to the contract consistently chooses those actions that are most likely to maximize his own expected utility in other words, both agent and principal always act so as to promote their own self-interest.

Although the assumption that both parties seek to promote their own self-interest is controversial among economists, a fact that Jensen and Meckling acknowledge, it remains the central tenet of agency theory. Jensen and Meckling emphasized the precise nature of the costs inherent in all agency situations by isolating three components: Depending on the situation, the costs of agency can be quite significant in relation to the size of the project.

Viewed from a perspective of rational choice i.

Principal–agent problem

In other words, there is a high likelihood that the agent will place greater priority on actions that will serve the interests of the agent rather than the principal. This lesson explains agency relationships. Principal and Agent Wilma works for me at my pet grooming business, Barks and Bubbles.

I'm the owner and in the process of restocking my inventory in my pet supply department, so I send Wilma to order some products for my store. This means Wilma is an agent, or a party who is legally authorized to act on behalf of another party in business transactions.

agency relationship economics and history

I, on the other hand, am a principal. A principal is a party who gives legal authority to another to act on his or her behalf in business transactions. Both principals and agents can be individuals or can be business entities. Wilma and I have an agency relationship.

This is a business relationship where a principal gives legal authority to an agent to act on the principal's behalf when dealing with a third party.

agency relationship economics and history

When Wilma places orders for my store, I am the principal and Wilma is working as my agent. Agency All agency relationships are fiduciary relationships. This means the relationship involves a certain level of trust and confidence.

Agency Relationship: Definition, Principles & Problems - Video & Lesson Transcript |

The agent is obligated to act in the best interests of the principal because the agent's actions will create legal obligations for the principal. The agency relationship allows the agent to work on behalf of the principal as if the principal was present and acting alone.

For example, let's say Wilma contracts with Rusty's Rawhide to buy rawhide bones.

agency relationship economics and history

Rusty's delivers the bones, but Barks and Bubbles fails to pay the bill. As the principal, I'm legally responsible for Rusty's bill even though I never personally made this business deal. If Rusty's decides to sue for collection of the bill, they'll likely sue Barks and Bubbles and me, rather than Wilma. As long as Wilma was properly acting as my agent when she made this deal, she's not legally responsible.

Agency Relationship: Definition, Principles & Problems

Express and Implied Agency Wilma and I have an express agreement, which means that both the principal and agent agreed to the agency relationship through a written or oral agreement.

I asked Wilma to purchase supplies on my behalf, and Wilma agreed to do so. All agency agreements are created through the intent of the parties, and we clearly intend to act in an agency relationship.

agency relationship economics and history

However, not all agency agreements are express agreements. Agency can also be created through an implied agreement.