Agency Costs Analysis in Advanced Financial Accounting Scenarios

This report analyzes agency costs in three distinct scenarios within the context of advanced financial accounting. The first scenario explores the agency costs associated with Birm Equity's relationship with management, differentiating between separation and non-separation, and assessing the impact on investors. It emphasizes the significance of corporate governance mechanisms, such as board composition and the role of independent directors, in mitigating agency costs. The second scenario focuses on a situation involving Tori, evaluating the agency costs arising from potential opportunistic behavior by management and the importance of establishing robust corporate governance practices, including the separation of CEO and Chairman roles, and independent committees. The third scenario examines the impact of high debt levels on agency costs, highlighting the increased risk of self-serving behavior by agents and the need for specific corporate governance measures to protect shareholder interests. The report references key academic sources to support its analysis.

ADVANCED FINANCIAL ACCOUNTING
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SCENARIO 1
Birm Equity is separated from management
In this scenario, an investor would have medium level of agency cost since there is separation
of management and dominant shareholder. This would result in the management being under
check. The agency costs would be in the form of “bonding costs” of agents considering 48%
control of the voting rights by Birm Equity and hence they can change the management if
they wish (Jensen & Meckling. 1976). Also, for small investors, there may be risk of
exploitation from a large investor like Brim Equity owing to which the board structure
becomes critical especially in relation to majority representation of independent non-
executive directors on the board so that minority interests can be safeguarded (Coffe et. al.,
2018).
Birm Equity is not separate from management
In this scenario, an investor would have high level of agency cost as the management and
dominant shareholder are not separate. The agency costs would be in the form of monitoring
the agents and also agents acting in an opportunistic manner as there may of collusion
between the management and dominant shareholders which enhances the risk of financial
fraud (Jensen & Meckling. 1976). In order to address the same, various corporate governance
measures include independence of external auditor, independent working of risk
management, audit committee, remuneration committee and all being composed primarily of
independent non-executive directors coupled with the board of director being headed by an
independent non-executive director (Arens et. al., 2013).
Scenario 2
In this scenario, Tori would have medium levels of agency costs as while there is no risk of
exploitation from fellow shareholders, there is risk of management acting in an opportunistic
manner. The type of agency cost would be incurred in the form of monitoring costs on the
part of the principal besides the agent acting in a manner that tends to serve his/her self-
interest instead of shareholders (Jensen & Meckling. 1976). Since there is no dominant
shareholder hence proper corporate governance mechanisms need to be put in place. These
include the following (Arens et. al, 2013).
 CEO and Chairman of the Board to be vested in separate people.

 The Chairman of the Board must be an independent non-executive director
 The board must comprise of majority of independent non-executive director
 Risk management committee and Audit committee to be comprised solely of
independent non-executive directors.
Scenario 3
In this scenario, Tori would have high levels of agency costs since the company has a high
amount of debt and may be susceptible to liquidation which may prompt agents of the
company to be self –serving (Kim & Sorensen, 1986). The type of agency cost would be
incurred in the form of monitoring costs on the part of the principal besides the agent acting
in a manner that tends to serve his/her self-interest instead of shareholders(Jensen &
Meckling. 1976). The various corporate governance mechanisms that would be found
suitable in this case are as follows (Arens et. al., 2013).
 CEO and Chairman of the Board to be vested in separate people.
 Risk management committee and Audit committee to be comprised solely of
independent non-executive directors.
 The board must comprise of majority of independent non-executive director
References

Arens, A., Best, P., Shailer, G. & Fiedler,I. (2013). Auditing, Assurance Services and Ethics
in Australia, 2nd ed., Sydney: Pearson Australia
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.
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?, Columbia Business
School Research Paper <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3100995>