Agency Cost Analysis: Impact on Corporate Governance and Liquidity

This report provides an analysis of agency costs within the context of financial accounting, exploring the relationship between agents and principals and the conflicts that arise due to differing interests. The report examines three scenarios, assessing the impact of shareholder influence, investment strategies, and debt financing on agency costs, corporate governance, and liquidity. It references key academic works to support its arguments. The analysis highlights how agency costs can influence corporate governance and financial performance, offering insights into how companies can develop policies to mitigate conflicts of interest and optimize financial outcomes. The report emphasizes the importance of aligning incentives between agents and principals and managing the risks associated with debt and investment decisions. It underscores the need for good corporate governance to navigate these challenges and maximize shareholder value.

Running head: AGENCY COST 1
Advanced Financial Accounting
Student’s Name
Institutional Affiliation

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Agency Costs
Agency cost is the cost which results from the relationship between the agent and the
principal, where an agent develops a certain behaviour which is against the principal's interests.
Agency cost usually arises where the circumstances surrounding the description of agency theory
occur in a company. Principal-agent conflict normally arises due to agent’s private interests
which contradicts the principal's objectives in an organization. The amount of the agency cost in
a company depends on the way the agent relates to the principal in the organization. Agency
costs if not properly managed can sometimes affect the corporate governance or liquidity
position of the company.
In the first scenario, where Birim is separated from the management, agency cost will
increase. The rising of the shares of ABC Company by Brim from 25% to 48% makes the
shareholder the largest investor in the company. According to (Coffee et al., 2018), there is a
tendency or behaviour of the major shareholders to exploit the less powerful and minor
shareholders. On the other hand, if Birim equity is not separated from the management, the
impact of the increase in the number of shares held by the Birim Company will have a moderate
effect on the agency cost for the company. The agency cost is affected in this case because Birim
would acquire more shares from the Company thereby becoming a dominant shareholder and
hence the company agency costs for the Herald Sun would increase.
In scenario two, the Liquidity of the company is maintained as the company receives
more investment. There would be a change in the risk level since the agent needs to work
towards achieving the goals of the principal. The investor will be dominant in the business and
the shareholders will follow the needs of the company, in this case, good corporate governance

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practices require that the company has to use the extra money to invest which makes the
company earn more profit (Jensen & Meckling, 1976). By acquiring shares, Michael Bloomberg
would have to maintain agency costs in the company through the investment.
In the third case, there will be a high risk of investment held by Tori in the Dada PLC due
to its huge bank loan in the books of account. As postulated by Kim and Sorensen,1986 this
scenario is known as, "the agency cost of debt". The borrowing will work in favour of the
principal in this case if the management of the Dada Company uses the borrowed funds in
financing business operations. Borrowed funds if used to finance the activities of a company
have an effect of reducing the agency cost of the company as a result of good corporate
governances. In this case, the principal should not interfere with the strategies of the agent.
In all the three scenarios agency costs are high, moderate and low respectively. The
agency cost is influenced by liquidity and corporate governance. These scenarios create
problems which could help the respective companies to develop good corporate policies. The
principals should, therefore, focus on the incentives that motivate the agents for them to act
according to their interests since they always lack information about the strategy that the agent
uses to perform operational tasks.

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Reference
Coffee, J., Jackson, R., Mitts, J., & Bishop, R. (2018). Activist Directors and Agency Costs:
What Happens When an Activist Director Goes on the Board?. SSRN Electronic Journal.
doi: 10.2139/ssrn.3100995…(Coffee, et al 2018)
Jensen, M., & Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs and
ownership structure. Journal Of Financial Economics, 3(4), 305-360. doi: 10.1016/0304-
405x(76)90026-x…(Jensen & Meckling, 1976)
Kim, W., & Sorensen, E. (1986). Evidence on the Impact of the Agency Costs of Debt on
Corporate Debt Policy. The Journal Of Financial And Quantitative Analysis, 21(2), 131.
doi: 10.2307/2330733…(Kim & Sorensen, 1986)