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This posting addresses agency relationships and costs.

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Suppose you and two friends each invested $100,000 in an oil and gas partnership. The general partner, XYZ Gamble, Inc., invests no cash but makes all operating decisions for the partnership, including where and how deep to drill for oil. Drilling costs plus a management fee are charged against the $300,000 of cash you and your friends invested. If oil is found, you each get 15% of partnership net income with the remaining 55% going to XYZ Gamble. But if the wells are dry, you get nothing except any cash that remains.

What is an agency relationship, and what are agency costs? How do these concepts apply to your investment in the oil and gas partnership?

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The solution provides a good discussion on agency relationships, agency costs, and how the concepts apply to an investment in an oil and gas partnership. References are provided.

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An agency relationship is a relationship that has formed in which the members can act on behalf of the principal. It is a fiduciary relationship between agent and principal. In the partnership scenario above, the general partner invests no cash but makes all operating decisions for the partnership. The company that is the general partner is acting out of an agency relationship for the other two partners, which is an implied authority due to the structure of a partnership. Agency costs are ...

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