Agency Theory

Agency theory is a theory in organizational economics and corporate governance that examines the relationship between a principal, such as a company's shareholders, and an agent, such as its managers, who is engaged to act on the principal's behalf but may have different interests and access to different information. The theory analyzes the agency costs that arise from this misalignment, including the costs of monitoring managers, the costs of structuring incentives such as executive compensation to align managerial and shareholder interests, and the residual losses that remain even after such mechanisms are in place. Agency theory has been highly influential in corporate governance research and practice, shaping debates over executive pay, board oversight, and the design of incentive contracts.