Agency Costs are a market’s imperfection, which can influence business’s value.
Agency costs appear because of the relationship between the different bussines’ stakeholders. In most case because the members of the company have different interest, what we call “Conflicts of interest».
There are more than one type of Agency costs.
At first time, we will study “Agency costs with creditors”.
At the second time, “Agency costs between management and owners”.
“Agency costs with creditors”.
The owners and/or management of the company can take opportunists decisions when they receive external financing, and it can involves an agency cost.
The reasons for which these conflicts of agency can arise are different. Some examples are those ones:
– A distribution of dividends higher than the previse distribution. The reason of the agency cost is that if the company gives part of the own resources, it reduces the solvency of the company.
– Debt emission of equal or major priority, provided it increases the risk of non-payment of the interests and principally of the already existing debt.
– Rejection of profitable investments to do other investments that have a higher risk. (infrainversión and overinvestment).
“Agency costs between management and owners”.
When the owners of the company have contracted other persons as executives it can generate conflicts between both groups.
When the dispersion of the property is high, the owners have not incentives to control directly the managerial decisions, because they will assume the cost of exercising the mentioned control, but they only will benefit from the proportional part to his participation. We know this case as “problem of the free-rider”.
This can give a facility to the executives about taking opportunists decisions in favor of his own interests (prestige, power, promotion, safety and much more).
This way, the company’s director will prefer to do investments which involves less risk because, although it has low value, is a way to guarantee the growth and permanency of the company.
Also they can use the resources that have to his disposition for personal benefits, like win a higher salary or receive goods of luxury.
But the stakeholders can reduce the opportunist decisions of the direction increasing the level of debt. I explain why:
– On one hand, the debt includes payment of interests, and it reduces the resources of free disposition in hands of the executive to use to take opportunist decisions.
– On the other hand it will be a higher control of the company on the part of creditors and financial markets.
– Other ways to reduce the Agency Costs could be the next: Giving more attention to the regulation of organized markets, Regulating the public bids of acquisition or OPAS, Fulfilling the economic laws, enabling a safety mechanism, etc.
The agency costs between owners and executives also meet aggravated when the directors have a better information about the situation and expectations of the company that have the owners.
We can divided agency costs in two groups: Indirect Cost of agency, and direct costs of agency.
An indirect cost of agency can be a lost opportunity. I explain an example about that:
“Let’s suppose that the company is considering to realize a new investment. It hopes that the new investment will have a favourable effect in the value of the actions, though also it is a relatively risky business. The owners of the company will want to realize the investment because it will increase the value of his actions, but probably the administrators do not wish because there exists the possibility that the things go out badly and lose his employments or because they do not have the necessary liquidity. If the administration does not realize the investment, the shareholders can have lost a valuable opportunity.
Probably having good usefulness, but in the moments of the opportunity of investment problems of liquidity are had, the administrators do not happen to sources of financing to realize the project and to obtain major performances.” (www.investopedia.com/terms/a/agencycosts)
On other site, the direct costs of agency are two forms:
– The first one is the one that is a benefit to the administration but harms the shareholders. For example, when with the funds of the company, someone pay a ticket for a plane in business, superluxuy, expensive restaurants…
– The second type there is the payment of high salaries to not productive but preferential executives, the payment of high not widespread presentations, etc.
To conclude, when the company administers of separated form this type of costs of agency, we can observe that his volume concerns in considerable form the usefulness of the company and, obviously, it goes to the detriment of the shareholders who do not see growing the value of his actions. This can harm the shareholders, who see that the value of his actions does not increase.