Agency Theory

Think of the term "agent" as it's used in day-to-day life, like those slick $3,000-suit-wearing guys who work for actors and athletes, spending their days yelling into Bluetooth sets and eating expensive lunches in various locations in L.A. or New York. "Show me the money" vibe. These agents work for their clients, getting them as much money as possible to act or play football or whatever. The agent takes care of the financial stuff, so the client can focus on starring in Marvel movies or playing for the Cowboys.

Now take this vision and apply it to the world generally. In many aspects of financial life, there are agents and there are principals. Agents work on behalf of the principals, managing money or running their businesses or working to achieve specific goals.

But while agents work for principals to get stuff done, the interests of the two groups aren't always in sync. To go back to the original agents we were talking about: say a basketball player wants to play for his hometown team, but has a bigger money offer from someplace else. The player (the principal, in this case) might prefer the more sentimental choice. But the agent, who gets 10% of whatever money his client gets, wants him to take the higher money offer. After all, he can't take 10% of sentiment. He has an interest to push the higher-money offer over the home town.

In a nutshell, that's agency theory. It's a way of discussing the various intricacies of the agent-principal relationship. (See: Agency Cost.)