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agency costa form of failure in the contractual relationship between a PRINCIPAL (the owner of a firm or other assets) and an AGENT (the person contacted by the principal to manage the firm or other assets). This failure arises because the principal cannot fully monitor the activities of the agent. Thus there is a possibility that an agent may not act in the interests of his principal, unless the principal can design an appropriate reward structure for the agent that aligns the agent's interests with those of the principal.
Agency relations can exist between firms, for example, licensing and franchising arrangements between the owner of a branded product (the principal) and licensees who wish to make and sell that product (agents). However, agency relations can also exist within firms, particularly in the relationship between the shareholders who own a public JOINT-STOCK COMPANY (the principals) and salaried professional managers who run the company (the agents). Agency costs can arise from slack effort by employees and the cost of monitoring and supervision designed to deter slack effort. See PRINCIPAL-AGENT THEORY, CONTRACT, TRANSACTION, DIVORCE OF OWNERSHIP FROM CONTROL, MANAGERIAL THEORIES OF THE FIRM, TEAM PRODUCTION.