Financial Management Report: Agency Costs and Shareholder Interests

This report delves into the concept of agency costs within financial management, highlighting the inherent conflicts of interest between managers and shareholders. It explains how these costs arise from disparities in objectives, where managers may prioritize company growth and personal benefits while shareholders aim to maximize their wealth. The report explores how agency costs manifest in public companies and examines the financial incentives used to align managerial actions with shareholder interests. It outlines four key costs incurred by shareholders to mitigate agency problems: monitoring costs, bonding costs, opportunity costs, and structuring costs. The report references several academic sources, including Gitman, Juchau, and Flanagan (2015), LaRiviere, McMahon, and Neilson (2017), Petty, Titman, Keown, Martin, Martin, and Burrow (2015), and Posner (2014), to support its analysis of agency costs and their implications in financial management.

Running Head: Financial Management
Part B: Essay

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Agency costs are actually the type of cost which occur internally, these arise and to be paid
by the agent on behalf of the principal. The major cause of these types of cost is core
problems like conflict of interest between management and shareholders. As the shareholders
perspective is to run the company in such a way that would maximise the interest of
shareholders and to maximise their wealth (Petty, Titman, Keown, Martin, Martin and
Burrow, 2015). On the other side management want to run the company in such a way that
will help in growth of the company and in such a way that will maximise the powers of the
management. Both the management and shareholders want to enhance their interest areas in
the company that will lead to conflict of interest between management and shareholders. For
example: Agency costs in a company occurred because of the conflicts between manager’s
and shareholders of the company (Posner, 2014). Shareholders want to maximise their wealth
and the company to run in such a way that will maximise their wealth on the other hand
manager’s want that the company’s profits will maximise that will positively affect their
salaries and increase the level of their bonus. Both manger’s and shareholders views are
conflicting this will tend to increase the happening of agency costs.
In public companies, agency cost take place when the agent say company’s
management keeps their own or say personal interest above the interest of shareholders say
principle. We can say that agency cost can be either of the two:
a) The cost incurred if the agent uses the company’s asset for his own use or for personal
benefit or
b) The techniques used by the principals to mitigate the interest of shareholders or to
restrict them from prioritising their interest, the cost involved for these techniques is
agency cost (LaRiviere, McMahon and Neilson, 2017).
Agency costs are the costs which are borne by the shareholders to prevent the agency
problems and to maximise their wealth. Shareholders offer some financial incentives to the
agents to keep their interest on top priority. This means that shareholders will offer incentives
to management when the share prices increases. These incentives in monetary terms which
are paid by the shareholders are an example of the agency cost. Shareholders need to incur
four types of costs these are:
Cost of Monitoring
Bonding Cost
Opportunity cost
Structuring Cost

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These costs are incurred by shareholder for their benefit as for maximisation of their wealth
but are not more than cost they incurred to earn that benefit (Gitman, Juchau, and Flanagan,
2015).

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References:
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
Higher Education AU.
LaRiviere, J., McMahon, M. and Neilson, W., 2017. Shareholder Protection and Agency
Costs: An Experimental Analysis. Management Science.
Petty, J.W., Titman, S., Keown, A.J., Martin, P., Martin, J.D. and Burrow, M., 2015.
Financial management: Principles and applications. Pearson Higher Education AU.
Posner, R.A., 2014. Economic analysis of law. Wolters Kluwer Law & Business.