agency relationship


agency relationship
A relationship in which a principal engages an agent to perform some service on his or her behalf; this involves delegating authority by the principal. As it has to be assumed that the agent will not always act in the best interests of the principal, the principal incurs costs in monitoring and controlling the behaviour of the agent. In turn, the agent will incur bonding costs in convincing the principal that the interests of the principal will not be harmed. The agent may also take decisions that do not always maximize the welfare of the principal; these decisions can result in what is called a residual loss. The sum of the monitoring and bonding costs together with the residual loss form the agency costs. Even in an unregulated economy managers may choose to provide financial statements, examined by independent auditors, to shareholders and creditors in order to reduce agency costs. By supplying informative financial statements to external parties on the basis of information held by them, managers may avoid costly disputes and more expensive mechanisms for controlling their actions. These aspects of an agency relationship are sometimes referred to as agency theory. The so-called agency problem that arises when shareholders and managers have different interests and asymmetric information was brought into sharp focus by the collapse of the US companies Enron and World Cons in 2002. See also goal divergence; signalling hypothesis

Big dictionary of business and management. 2014.

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