Agency costs are the incurred costs as a result of conflicts of interests between an agent and principles. These conflicts arise as the company’s managers strive to maximize their goals in the company’s share prices. Examples of the Agency costs include the costs incurred by executives on the corporate jet, or lavish dinner for executives. Also, agency costs can be frivolous such as the costs meant for an external auditor. Agency costs can also be caused by equity mispricing resulting from market imperfections. They include unequal access of prices, market participants who are unsophisticated, transactions costs, and information asymmetry.The rational assets pricing and efficient market hypothesis proponents indicate that stock mispricing, which is the deviation from the fundamental or intrinsic value, can be a temporary or short term phenomena that the arbitrageurs quickly exploit on it. The agency costs are associated with the conflicting objectives between the shareholders and managements. The costs are as results of information asymmetry, stock mispricing, and lack of transparency and the firm level.
Economic issue or an ethical issue
Agency costs are associated with the actions undertaken by the shareholders and managers who aim to fulfill their interests and not the firms’ interests. The agency problem is both an ethical and economic issue. When the company uses financial leverage, the managers can take actions that are only for their benefit and not their lenders. At the end, the actions reduce he claims made by the lenders, and the expected loss is seen in the lenders interests’ rate that they expect. It impacts on the economic issues of the company. The lack of ethical rules by the managers makes them ignore the consequences of their actions and is not willing to put other people’s interest ahead of theirs. The financial managers have the moral obligation to operate honestly and to ensure that their subordinators act in an honest manner by ensuring that they respect any financial transactions that they do (Perrino, Moles, & Kidwell, 2011, p 4).
Parrino, R., Moles, P., & Kidwell, D. (2011) Fundamentals of Corporate Finances. John Wiley and sons publishers, p 4