Problem: 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?