This chapter in the Oxford Handbook of Law and Economics offers an economic theory of how the law of agency and partnership facilitates economic transactions using these two devices. Agency and partnership help us broaden the traditional, simplified Coasian dichotomy between contract, used in situations of low transaction costs, and the firm, used in situations of high transaction costs. Although economists tend to view “agency” solely from the perspective of “agency costs,” from a legal point of view, the fundamental aspect of agency law that distinguishes it from contract is that agency involves relationships among three parties: the principal, the agent, and the third party with whom the agent interacts. Agency law both facilitates contracts between principals and third parties, by allowing intermediaries to bind principals to those contracts, and protects third parties against unwanted harms caused by the use of agents. The key to understanding the law of agency is that the tripartite nature of the agency relationship enables any two of the parties to collude against the other. The primary economic purpose of agency law is to enhance the benefits of agency the deterring such collusion.
The law of partnership takes a step beyond agency because it involves multiple principals who jointly own assets. Partnerships facilitate contracting by enabling the pooling of resources in the joint pursuit of a business enterprise. Although economists recognize firms such as partnership as a “nexus of contracts,” the law of partnership focuses on the problems caused by the fact of multiple owners. Multiple ownership complicates both the agency law concerns with contracting with third parties and protecting those third parties from harm, because partners are in some sense principals and in some sense agents of the partnership as an entity. Moreover, multiple ownership of property implies shared control over that property, and thus requires rules of internal governance and management. Shared ownership also creates the possibility of misappropriation of jointly owned property by one of more partners and disputes about what counts as joint property. The multiple owner aspect of partnership creates collusive possibilities beyond those in simple agency. Partners can collude against other partners or the partnership, can collude with third parties against the partnership, or can collude against a third party. The primary economic purpose of partnership law is to enable partners to realize the benefits of joint ownership while minimizing the costs associated with these more complex forms of collusion.
George M. Cohen, Law and Economics of Agency and Partnership, in Oxford Handbook of Law and Economics, Oxford University Press, 399–422 (2017).