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Agency Theory

Agency theory starts with the idea that a firm, or organization, is the sum of a number of agreements between a principal (e.g., the firm, a manager, and society in the case of public organizations) and agents (e.g., employees). In general, the goal of the firm, or the sum of agreements, is to maximize output using as few resources as possible. In the typical firm, it is impossible for the principal to completely monitor the actions and behaviors of the agents within the firm. Instead, firms put in place a set of contracts, inducements, or sanctions (hereafter referred to as contracts, for simplicity) to incentivize actors to align their behavior with the goals of the firm. The contracts establish a set of performance goals or ...

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