Agents are commonly engaged by principals due to different skill levels, different employment positions or restrictions on time and access. For example, a principal will hire a plumber — the agent — to fix plumbing issues. An agent may be motivated to act in a manner that is not favorable for the principal if the agent is presented with an incentive to act in this way.
Agency costs are internal costs incurred due to the competing interests of shareholders principals and the management team agents. Expenses that are associated with resolving this disagreement and managing the relationship are referred to as agency costs.
The key takeaway point is that these costs arise from separation of ownership and control. Shareholders want to maximize shareholder value while management sometimes makes decisions that are not in the best interest of shareholders i.
For example, agency costs are incurred when the senior management team, when traveling, unnecessarily books the most expensive hotel or orders unnecessary hotel upgrades.
The cost of such actions increases the operating cost of the company while providing no added benefit or value to shareholders. Agency costs fall into 2 categories: Direct and Indirect Agency Costs Agency costs are subdivided into direct and indirect agency costs.
There are two types of direct agency costs: Corporate expenditures that benefit the management team at the expense of shareholders An expense that arises from monitoring management actions to keep the principal-agent relationship aligned.
The first type of direct agency costs is illustrated above, where the management team unnecessarily books the most expensive hotel or orders unnecessary hotel upgrades that do not add value or benefits to shareholders. Indirect agency costs refer to lost opportunity.
Say, for example, shareholders want to undertake a project that will increase stock value. However, the management team is afraid that things might turn out badly, which might result in the termination of their jobs.
If management does not take on this project, shareholders lose a potentially valuable opportunity. Agency Cost of Debt Agency cost of debt is the increase in the cost of debt or the implementation of covenants for fear of agency cost problems. Debt financiers in a company are not in control of their money — the management is.
Agency cost of debt generally happens when debt holders are afraid the management team may engage in risky actions that benefit shareholders more than bondholders.
For fear of potential principal-agent problems in the company, debt suppliers may place constraints such as debt covenants on how their money is used.
The Principal-Agent Relationship The principal-agent relationship plays a major role in agency costs. The principal-agent relationship is an arrangement between two parties in which one party the principal legally appoints the other party the agent to act on its behalf.
The principal-agent problem occurs when the interests of the principal and agent are not aligned.
|1 Approved Answer||How do convertible bonds help reduce agency costs? The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets.|
As a result, agency costs are incurred. To identify a potential principal-agent problem, consider the following example: You hire the services of a roofer to fix your leaking roof.
A principal-agent problem can arise as the interest of the roofer may not be the same as yours. The roofer, knowing that he is paid hourly, may try to take as much time as possible to fix the roof so he can make more money.
You are unable to prevent this, as you know very little about repairing roofs. The agency cost is the extra amount you pay the roofer to get the roof fixed. Reducing Agency Costs The most common way of reducing agency costs in a principal-agent relationship is to implement an incentives scheme.
There are two types of incentives: Financial incentives are the most common incentives scheme. For example, if an organization achieves a certain goal, the management team would receive a monetary bonus.
Financial incentives based on performance help motivate agents to act in the best interest of the company.Agency costs are the costs of disagreement between shareholders and business managers, who may not agree on which actions are best for the business.
There is an inherent cost to this disagreement and leads to what is called "the agency . To reduce agency cost, accounting should provide the information for management stewardship. Then, which item can be more directly related to the 1. The pecking order theory of capital structure rests on an assumption of 1.
Agency costs 2. Barriers to entry 3. Asymmetric information 4. Tax shields cost of financial distress The pecking order theory of capital structure rests on an assumption of 1. Agency costs 2. Barriers to entry 3.
Total agency costs to firm X include agency costs of equity (S) and agency costs of debt (B) as shown in equation (1). When firm X introduces other stakeholders. 答案 1 Agency cost are the costs that arise from conflicts of interest between shareholders and managers.
Agency problems is defined as the conflict of interest between the goals of the firm’s owners and its managers. Does this cost appear to be consistent with the riskiness of the issue?
(7) What is the after-tax cost of the convertible bond? e. Mr. Duncan believes that the costs of both the bond with warrants and the convertible bond are close enough to call them even and also are consistent with the risks involved.