Agency Costs in Corporate Governance: Analysis of Different Scenarios

ADVANCED FINANCIAL ACCOUNTING
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SCENARIO 1
“Birim Equity is separated from management”
A given investor would be exposed to medium agency costs in the given scenario. On one
hand an activist dominant shareholder would act as a check on agent but there are risks of
minority shareholders being dominated coupled with higher risk of sensitive information
leaks. The primary agency costs will be incurred as agents “bonding costs” for convincing the
board as a dominant share of voting rights is with one investor i.e. Birim Equity Fund (Jensen
& Meckling. 1976). As an investor, there is chance of exploitation from the dominant
investor coupled with issues of information leak. As a result, corporate governance measures
would relate to strengthening the disclosures mechanism so that information asymmetry is
minimised. Also, board composition with regards to independent non-executive members is
pivotal (Coffee et. al., 2018).
“Birim Equity is not separate from management”
A given investor would be exposed to high agency costs in the given scenario as there is no
separation between the dominant shareholder and the management which enhances the risk of
financial fraud. The agents costs would comprise of the following (Jensen & Meckling.
1976).
 Opportunistic behaviour of the agents especially with no clear line between ownership
and management.
 Agency costs related to agent monitoring especially on the part of non-dominant
shareholders
In such a scenario, corporate governance mechanisms would aim towards maintaining the
independence of the board (appointment of majority non-executive and independent
directors), independence of internal audit committee, risk management & remuneration
committee (constituting entirely of non-executive independent directors) (Arens et. al., 2013).
Scenario 2
Considering the scenario provided whereby there is no large shareholder, the underlying
agency costs for an investor like Michael would be medium. The agents costs would
comprise of the following (Jensen & Meckling. 1976).