A short introduction to agency theory - Part 2, Costs of Agency

A short introduction to agency theory - Part 2,
Costs of Agency

Click here for part Part 1

This gives rise to the “costs of agency”, which are costs incurred where the principles have incentives to do things that are not in the interests of the principles.  For example, managers (like any employees) may steal thing from work, of they may use company resources in a selfish and extravagant way.  Have you ever seen the offices of the big bank’s CEOs?  Do they really need to fly in their own private helicopter or Lear Jet? Or perhapsthe trip in a regular jumbo get the job done just as efficiently.  These lavish items are called “perquisites”.  A perquisites is any service or thing regarded as a special right or privilege enjoyed as a result of one's position.  It’s the whole point of climbing to the top of the corporate ladder.

A short introduction to agency theory - Part 1

A short introduction to Agency Theory

Where ever you look in society, you can see people doing things for other people.  Rather than asking as a blind unthinking robot merely processing instructions, the doing person often has some degree freedom as to how they go about the task. 

Let’s call person doing things, “the agent” and the person who benefits “the principle”.  In the standard corporate setting, you have shareholders who pool together cash and delegate the authority to manage those funds as they best see fit.  We actually see this in all walks of life.

Perhaps the most fundamental example is that of mother and child.  The child is unable to do things for itself, and so the mother must act to feed, clothe and protect the child in a way that is selfless to the mother and importantly, always in the child’s best interest.  In this sense, the CHILD is the principle and the MOTHER is the agent of the child.