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.)

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Finance: What is principal?707 Views

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finance a la shmoop what is principle answer its the loan amount you borrow

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when you do you sign a bunch of papers promising to pay back the principal and [Person signs paper]

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the interest that goes with it and that interest is like rent you have to rent

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that money you swear up and down you'll pay back the principal that princess is

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not necessarily your pal it might be a monkey on your back it might be a mule [Mule kicking a man]

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that kicks you the wrong way but you owe it you owe that principal to the lender

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who loaned it to you and you want to put it on a diet as fast as you can

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why well because when that principal shrinks the rent you owe on it shrinks

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as well all right here's some simple math you borrow 40 grand by a

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three-year-old ludicrous mode enabled Tesla with a few minor dents and you [Man driving a supercar]

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know you got a few shards of deer antlers stuck in the grille there for

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free you are considered a risky bet by the lenders loaning you your money or

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principle partly because of the way you drive so the rent on that principle 12%

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a year or 1% a month big interest rates because well you're such a crappy driver

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so on 40 grand of principal the cost to rent that money is 400 bucks a month or

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$4,800 a year that is just to stay even on the principle you've borrowed you [Principal interest payment chart appears]

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have to pay $400 every month and that's just the interest if you paid 30 40 50

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60 months of 400 bucks a month well you would still owe that principal of 40

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grand because all you did was baby interest or rent on it

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ouch but what if he went six months paying a full thousand dollars a month

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yes much would go from not eating or something like that well what would [Guy driving blue tesla]

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happen think about that first month you've quote overpaid unquote by 600

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bucks so if your loan resets or recalibrates every month well then you

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month of paying a grand your 40 grand in debt goes down to thirty nine thousand

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four hundred dollars pay a thousand bucks another month and while you're

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only now that monthly rent was reset at one percent of thirty nine thousand four

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hundred or 394 bucks right six dollars cheaper

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than the 400 you started with but you paid a grand so now you get to use 606

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dollars to pay down the principal and see the math there the new principal

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thirty nine thousand four hundred minus at six hundred six it's now thirty eight

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thousand seven hundred ninety four dollars that you owe do a grand another

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month and you get to pay down even more of the principal about three hundred

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thousand dollars a month payment so check out what happens when you just

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more than minimum payments when you can and you know really as much as you can

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you know don't feel like a dear

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