| Agency Problem/Costs
Agency relationship exists when one or more persons (principal) contracts with one or more persons (the agent) to make decisions on their behalf. This relationship gives rise to agency problem.
Agency problem/costs arise when there is conflict of interest between the managers and stockholders, and the stockholders and bondholders.
Managers verses stockholders
This is where there is a conflict of interest between the managers and the stockholders. The managers’ personal goals compete with the stockholders wealth maximization goals. The managers may pay themselves hefty salaries and allowances at the expense of wealth creation for the stockholders. The managers may also steal from the company and may not make profitable but risky investments for fear of losing their job if the investment does go as expected. Stockholders can make decisions to assure themselves that the managers act in their best interest (support wealth creation). This will reduce the agency costs and hence enhance stockholder wealth creation.
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