Advance Financial Accounting - Agency Cost Scenarios

This article discusses three scenarios related to agency costs in financial accounting. It covers the impact of separation of management and shareholders, the effect of limited shares on agency costs, and the role of bank loans in agency costs.

Running head: ADVANCE FINANCIAL ACCOUNTING
Advance financial accounting
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1ADVANCE FINANCIAL ACCOUNTING
Table of Contents
Scenario One:.............................................................................................................................2
Scenario Two:............................................................................................................................2
Scenario Three:..........................................................................................................................2
References..................................................................................................................................2

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Scenario One:
The scenario deals with the ABC Ltd that is an enterprise based in Australia and is a
large manufacturing firms with 25 subsidiaries which operates from different part of the
world. On 30th July 2018, Birim Equity fund acquired an additional 25% of shares of ABC
Ltd resulting in its total shareholding of 48%. The discussion deals with whether situation
would affect the agency cost for prospective investor if Birim Equity is separated from
management or not. In this context, The Agency costs refer to the internal cost that must be
paid to an agent acting on behalf of a principal (Jensen & Meckling, 1976). These costs arise
because of core issues, like conflicts of interest, between management and the shareholders.
In case the Birim Equity is separated from management, the higher agency cost may take
place since the principal is separate from the agent company. The management is a separate
entity from its shareholders. However in the case where the company of Birim Equity is not
separated from management there would exist no agency cost as the management and the
shareholders are the same. There exists no principal agent relationship (Kim & Sorensen
1986).
Scenario Two:
The second scenario deals with Michael Bloomberg who is a recent graduate of La
Trobe University and has received $0.5 million cash as his inheritance after the death of his
father. Michael has decided to invest his wealth in a listed firm which characterized by many
shareholders with each shareholder having a small amount of shares. The agency cost refers
to the internal cost that must be paid to an agent acting on behalf of a principal (Coffee,
Jackson, Mitts & Bishop 2018). It is the disagreement between the management and the
shareholders. Since the shareholders have limited amount of shares in the company, the
agency cist that would take place is high. The management overpowers the shareholders

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value. The type of agency cost that would take place is monitoring agency cost as the power
lies with the internal s of the company. A sound corporate governance and increase in the
shareholders value may reduce the problem.
Scenario Three:
In the third case the situation deals with Tori who is a small-time investor and has
decided to invest in Dada PLC. However, Dada PLC has a large bank loan on its books. The
agency cost that would take place in this case is much more less as the power lies in the
hands of the shareholders (Bosse and Phillips 2016). There will not be much disagreement
between the principle and the agent. The type of agency cist that can be identified in this case
is residual loss since Dada PLC has a large bank loan on its books. A sound corporate
governance strategy to overcome the loan may resolve this issue.

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References
Bosse, D.A. and Phillips, R.A., 2016. Agency theory and bounded self-interest. Academy of
Management Review, 41(2), pp.276-297.
Coffee, J. C., Jackson, R. J., Mitts, J., & Bishop, R., 2018. Activist Directors and Agency
Costs: What Happens When an Activist Director Goes on the Board?
Jensen, M. C., & Meckling, W. H., 1976., Theory of the firm: Managerial behavior, agency
costs and ownership structure. Journal of financial economics, 3(4), 305-360.
Kim, W. S., & Sorensen, E. H. 1986., Evidence on the impact of the agency costs of debt on
corporate debt policy. Journal of Financial and quantitative analysis, 21(2), 131-144.