What is Agency Theory?

Agency Theory is a concept explaining the relationship between principals (such as investors) and agents (such as a company executives). In this relationship, the principal appoints or hires an agent to perform work. The theory deals with two specific problems: firstly, that the aims of the principal and agent are sufficiently aligned to ensure that the achievement of one does not inhibit the other party's ability to fulfil theirs; and, that the principal and the agent mediate any different tolerances for risk.