Contractual Obligations in Business

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The Agency Model and its integral component—the agency relationship serves as one of the most prolific examples of the inherent difficulties with regards to arriving at a mutually agreeable contract.First and foremost an agency relationship is one which is established when a principal (the owner) hires an agent (the contractor) to act on the principal’s behalf and to advance the principal’s goals (Macleod 2002, p. 220). Such relationships permeate the construction industry, just as they do everyday life. The contractor, as it undertakes the design or construction of a new facility. is an agent of the owner. Subcontractors are agents of the contractor when hired to help meet the contractor’s obligations. The individual engineer employee, expected to provide designs that will satisfy the owner/contractor agreement, is an agent of the design contractor employer.Conflicts of interest inevitably exist in agency relationships. Solutions to the resulting problems are an increasing area of study in economics in recent years (Charreaux 2002, p. 251). Considered in a construction context, this growing body of knowledge offers guidelines for the design of contracts to maximize the alignment of contractors with owners’ objectives.Before examining the economist’s perspective of the owner/contractor relationship, two points are worth noting. First, the economic concept of the agency should not be confused with the agency concept of contract law, in which a principal and agent agree that the agent can and will act on the principal’s behalf in dealing with a third party (Sweet 1994). As long as the agent acts within its authorized scope, a third party can negotiate and form a contract with the principal through the agent. While issues of the legal agency may accompany economic agency examples, they are not central to the notions expressed in this paper.