Developed by Stephen A. Ross (The Economic Theory of Agency, 1973) and by Michael C. Jensen and William H. Meckling (Theory of the Firm, 1976), after Adolf A. Berle and Gardiner C. Means's split of ownership from control (The Modern Corporation and Private Property, 1932).
Analyzes any arrangement where one party acts for another, naming where their goals split, what the agent knows that the principal cannot see, and what oversight costs.
When to reach for it
When designing pay, a vendor contract, or delegated authority, and the person doing the work cannot be watched all the time.
How it runs
- Name the principal and the agent precisely.
- Map where the two parties' goals diverge.
- List what the agent knows or does that the principal cannot see.
- Estimate what it costs to verify the agent's work.
- Design incentives, contracts, or monitoring against the biggest gap.
Where it sits in SOLVE eX
Go to the source
- The Economic Theory of Agency: The Principal's Problem, American Economic Review, 1973
- Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics, 1976
- The Modern Corporation and Private Property, 1932