Agency Theory

Micro-economicsts use agency theory to study the problems of motivating and controlling cooperative action (Scott p. 105). Their primary focus is the situation where one party (the principal) seeks some outcome but requires the assistance of an agent to carry out the necessary activities (e.g, supervisor-subordinate). "It is assumed that both parties are motivated by self-interest, and that these interests may diverge" (Scott p. 105).

Agents usually know more about the tasks than the principals (information assymetry). Principals seek to gain information (by inspection or evaluation), develop incentive systems to ensure agent actions in the principal's interests. Agency theorists attempt to design the most cost effective information systems.

Contributors are Alchian and Demsetz (1972), with a nice review by Eisenhardt (1989)

Agency Theory and the Creation of Organizations
Agency theory states that we need organizations to help monitor and give incentives to agents doing coordinated, cooperative work. "Cooperative situations involving complex tasks give rise to hierarchical structures" (Scott p. 162). When ownership is concentrated in one principal, then contracts are needed to define obligations and incentives, especially those in the periphery of the organization. "Agency theory, recognizing the costs of monitoring systems, stresses the need to design incentive systems that will induce all participants to contribute their fair share to the common enterprise" (Scott p. 162).