We define an agency relationship as

We define an agency relationship as a contract under which one or more
persons (the principal(s)) engage another person (the agent) to perform some
service on their behalf which involves delegating some decision making authority
to the agent. If both parties to the relationship are utility maximizers there is
good reason to believe that the agent will not always act in the best interests of
the principal. Theprincipalcan limit divergences from his interest by establishing
appropriate incentives for the agent and by incurring monitoring costs designed
to limit the aberrant activities, of the agent. In addition in some situations it will
pay the ngenr to expend resources (bonding costs) to guarantee that he will not
take certain actions which would harm the principal or to ensure that the
principal will be compensated if he does take such actions. However, it is generally
impossible for the principal or the agent at zero cost to ensure that the agent
will make optimal decisions from the principal’s viewpoint. In most agency
relationships the principal and the agent will incur positive monitoring and
bonding costs (non-pecuniary as well as pecuniary), and in addition there will
be some divergence between the agent’s decisions* and those decisions which
would maximize the welfare of the principal. The dollar equivalent of the reduction
in welfare experienced by the principal due to this divergence is also a cost
of the agency relationship, and we refer to this latter cost as the “residual loss”.