What relationships are the most common types of agency relationships?

Managing a business entails various responsibilities to handle and tasks to accomplish, which is understandably challenging for any individual.

If you are having a hard time taking care of other business responsibilities, then you may consider hiring agents to help you run your business more effectively. Whether you are occupied with handling other business matters, or you have to go on an out-of-town business trip, a skilled agent can help make an important commercial transaction and work on your behalf.

For this setup to be effective, you should first establish an agency agreement, define your relationship with your agent, and learn and understand more about your rights and obligations with one another. You may also seek legal assistance from commercial lawyers before getting into an agency agreement.

WHAT IS AN AGENCY AGREEMENT?

Agency agreements are established relationships that let agents act on behalf and in the interest of the principal.

WHAT IS THE RELATIONSHIP BETWEEN THE PRINCIPAL AND THE AGENT?

The principal refers to the individual who agrees to allow a trusted person to act on their behalf. On the other hand, the agent is the person acting on behalf of the principal.

WHAT DOES “AGENCY” MEAN IN COMMERCIAL RELATIONSHIPS?

In essence, an agency in a commercial relationship is fiduciary. This means that an agent is legally obligated to act in the principal’s best interest concerning their business, money, or property.

The most important part of the agency relationship is the trust and confidence between the agent and the principal. Since the agent should act only in the best interest of the principal, they must always act ethically according to the agency agreement.

WHAT ARE THE MOST COMMON AGENCY RELATIONSHIPS?

The most common agency relationships include the following:

• Employers and employees
• Lawyers and clients
• Real estate agents and auctioneers

Please take note that agency relationships can be tricky. However, keep in mind that rights and obligations depend on the type of agency relationship with your agent.

WHAT ARE SOME COMMERCIAL AGENCY RELATIONSHIPS? 

BROKERS

A broker is an individual or a business that will buy or sell goods or services according to the instructions of the principal.

If you are selling, a broker is responsible for increasing your profit. Meanwhile, if you are buying, they will help you get the best deal.

One example of this relationship is having a stockbroker. The stockbroker, who is the agent, will earn commission-based profits. They are obligated to look for the best buy or sell prices available in the market that is beneficial to you, the principal.

FACTORS

A factor, or a mercantile or a commercial agent, is vital in the buying and selling process of goods or services. Unlike brokers who are responsible only for helping you make the most profit or get the best deal, they can also hold possession of the goods you are aiming to buy or sell.

Agency theory is a principle that is used to explain and resolve issues in the relationship between business principals and their agents. Most commonly, that relationship is the one between shareholders, as principals, and company executives, as agents.

Key Takeaways

• Agency theory attempts to explain and resolve disputes over the respective priorities between principals and their agents.
• Principals rely on agents to execute certain transactions, which results in a difference in agreement on priorities and methods.
• The difference in priorities and interests between agents and principals is known as the principal-agent problem.
• Resolving the differences in expectations is called "reducing agency loss."
• Performance-based compensation is one way that is used to achieve a balance between principal and agent.
• Common principal-agent relationships include shareholders and management, financial planners and their clients, and lessees and lessors.

Understanding Agency Theory

An agency, in broad terms, is any relationship between two parties in which one, the agent, represents the other, the principal, in day-to-day transactions. The principal or principals have hired the agent to perform a service on their behalf.

Principals delegate decision-making authority to agents. Because many decisions that affect the principal financially are made by the agent, differences of opinion, and even differences in priorities and interests, can arise. Agency theory assumes that the interests of a principal and an agent are not always in alignment. This is sometimes referred to as the principal-agent problem.

By definition, an agent is using the resources of a principal. The principal has entrusted money but has little or no day-to-day input. The agent is the decision-maker but is incurring little or no risk because any losses will be borne by the principal.

Financial planners and portfolio managers are agents on behalf of their principals and are given responsibility for the principals' assets. A lessee may be in charge of protecting and safeguarding assets that do not belong to them. Even though the lessee is tasked with the job of taking care of the assets, the lessee has less interest in protecting the goods than the actual owners.

Areas of Dispute in Agency Theory

Agency theory addresses disputes that arise primarily in two key areas: A difference in goals or a difference in risk aversion.

For example, company executives, with an eye toward short-term profitability and elevated compensation, may desire to expand a business into new, high-risk markets. However, this could pose an unjustified risk to shareholders, who are most concerned with the long-term growth of earnings and share price appreciation.

Another central issue often addressed by agency theory involves incompatible levels of risk tolerance between a principal and an agent. For example, shareholders in a bank may object that management has set the bar too low on loan approvals, thus taking on too great a risk of defaults.

Reducing Agency Loss

Various proponents of agency theory have proposed ways to resolve disputes between agents and principals. This is termed "reducing agency loss." Agency loss is the amount that the principal contends was lost due to the agent acting contrary to the principal's interests. Chief among the strategies to resolve disputes between agents and principals is the offering of incentives to corporate managers to maximize the profits of their principals. The stock options awarded to company executives have their origin in agency theory and seek to optimize the relationship between principals and agents. Other practices include tying executive compensation in part to shareholder returns.

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