Exploring Agency Costs and Ownership Structure in Corporate Finance

This report delves into the complexities of agency costs and ownership structure, particularly focusing on the scenarios where management and ownership are either separated or combined. It highlights how agency costs, a fundamental concern for equity holders, are influenced by the alignment or misalignment of interests between agents (managers) and principals (owners). The analysis covers different investment scenarios, such as prospective investors dealing with major shareholders like Birim Equity, Michael Bloomberg's investment in a listed firm, and Tori's investment in Dada PLC, each presenting unique agency cost dynamics. The report emphasizes the role of both internal and external mechanisms of corporate governance in mitigating these costs, referencing established research on agency theory and the impact of debt on managerial behavior, concluding that effective corporate governance and strategic debt management can help align managerial actions with shareholder interests.

Running head: AGENCY COSTS AND OWNERSHIP STRUCTURE 1
Agency Costs and Ownership Structure
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AGENCY COSTS AND OWNERSHIP STRUCTURE 2
Agency Costs and Ownership Structure
It is undoubted true to say that agency cost is the most fundamental issue of concern that
is of interest to every equity holder be it a firm or an individual. Agency cost is of more
particular interest in the case where the management structure of a firm is different from its
ownership (Jensen & Meckling, 1976). Financial and economic advisers have emphasized in the
past that equity agency costs normally increase with the separation of the owners from the
control or ownership of a company. This notion still holds place up to date.
Scenario One
IF Birim Equity is not Separated from the Management
For the first scenario, a prospective investor is likely to incur more agency costs than the
existing shareholders. This is because major shareholders such as Birim are likely to have a
stronger control of the corporation thereby exploiting the less powerful shareholders because
they are advantaged through their stronger agency relationship with the management (agents).
The agency costs incurred in this scenario is as a result of opportunistic behaviour by the agent
(Coffee, Jackson, Mitts & Bishop, 2018). In this case, a minor shareholder at ABC would have to
use an external mechanism of corporate governance to intervene and serve his or her
objectives at the company.
If Birim Equity is Separated from the Management
In the case where Birim is separated from the management, a prospective investor would
also still incur agency costs but it would be at a medium level. Separating Birim from the
management would make it less powerful than before even though its shareholding would still
stand at 48%. In this case, a minor shareholder at the company would use an internal mechanism

AGENCY COSTS AND OWNERSHIP STRUCTURE 3
of corporate governance to exercise control and monitor the progress of the company and even
where the necessary taking part in suggesting corrective actions whenever he or she feels the
business has gone off struck.
Scenario Two
By investing $ 0.5 million cash in a listed firm, Michael Bloomberg from La Trobe
University would become part of the shareholders of the listed company he has invested her
funds to. Since most of the shareholders have invested small amounts of shares in the listed
company, the agency costs used in monitoring the costs of the agents would be low because it
would be distributed among various shareholders. Michael as part of the shareholders would also
incur little bonding costs in trying to induce the agent to act as per their wishes and not pursue
personal interests. In this case, the internal mechanism of corporate governance would be
appropriate to be used in addressing the agency costs.
Scenario Three
In this scenario, Tori would incur significantly medium agency costs by investing in
Dada PLC. The costs incurred would be used to monitor the actions of the agent. Since Dada
PLC has a huge bank loan, the investors would be at a better position since the agents would
have to contract with the debtholders - agency cost of debt (Kim & Sorensen, 1986). Agency cost
of debt has an effect of imposing pressure on the management to act as per principal’s interest so
as to pat back debt within the shortest time possible.

AGENCY COSTS AND OWNERSHIP STRUCTURE 4
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
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
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