agency theory
a theory that describes economic and organizational activity in terms of a series of agreements between principals, who require goods or services, and agents, who supply these goods or services. Central to this theory is the rational economic assumption that both agents and principals will attempt to maximize their respective utilities. An agency problem may arise when the interests of principals (e.g., shareholders in a company) and agents (e.g., managers) are not congruent, or when principals have insufficient information about the activities of agents. Agency theory suggests ways in which these problems can be reduced, notably by redesigning contracts or compensation schemes so that agents have an incentive to act in the best interests of principals (e.g., by some form of gainsharing) and by improving monitoring procedures.