Theory of Agency

The Theory of Agency addresses the relationship between a principal (such as an owner) and an agent (like an employee or manager) who is hired to act on their behalf. It explores how the agent's interests might differ from the principal's and how to design contracts or incentives to align those interests. The goal is to ensure the agent makes decisions that benefit the principal, despite potential differences in goals or information asymmetry. This theory helps explain issues in corporate governance, management, and organizational relationships, focusing on aligning incentives and managing the risks of self-interested behavior.