Simply put, an "agent" is created when a person (or entity) authorizes another person (or entity) to act on his or her behalf with a third party or third parties, i.e. other people or entities. The person giving authority is called the principal, while the person receiving authority from the principal is called the agent. So, in order to form an agency relationship there must be at least 2 people (or entities): (i) a principal and (ii) agent. Also, both the principal and agent must mutually agree to work together. Therefore, while a person may force another to work for him or her, this does not create an agency relationship.

In addition to the principal and agent, there are usually third parties involved with the agent and/or principal. The third parties are not part of the agency relationship, but they do interact with the principal and agent. So, the 3 people (or entities) generally involved in an agency situation include:

Agency relationships are created everyday.

For example, when you drive your friend’s car to take him or her somewhere, you are the agent and your friend is the principal. That’s because your friend owns the car as the principal and you’re acting on your friend’s behalf as the agent. In a similar example, if your parent ever gave you money to buy groceries, you were your parent’s agent and he or she acted as your principal. Alternatively, if you as a parent gave your child the car keys to buy you groceries, you automatically became the principal and your child became your agent. Third parties would be any people that the agent has to deal with on behalf of a task for his or her principal. So, in the grocery store example, the people working at the grocery store that interacted with the child would be the third parties.

In short, the principal is the "boss" of the agent for particular duties. In James Bonds novels and films, we don’t always know James Bond’s principal, i.e. boss. A principal that is unknown is called an undisclosed principal, while known principals are referred to as disclosed principals. In the novels by Ian Fleming concerning James Bond, Bond’s principal, i.e. boss, is identified as Sir Miles Messervy (even though he is generally referred to as "M").

Next, let’s take a look at how the authority is created in an agency relationship.