Introduction

Answer

A conflict of interest between the company’s management and company’s stockholders that is creates agency problems. Agency problems arise when agents work for principal. The shareholders are the principal’s the mangers are their agents. Agency costs are incurred when mangers do not attempt to maximize firm value and shareholders incur costs to monitor the managers and constrain their actions.

Description of the different types of Agency Cost.

1. Monitoring cost: Monitoring the activities of the management to prevent satisfying and maximizing owner wealth. It relates to the payment for audit and control procedures to ensure the management is working for maximizing owner’s wealth.
2. Bonding expenditure: Bonding protects the owners from the consequences of dishonest acts by management /managers. They firm pays to obtain fidelity bond from a third party bonding company to compensate for financial losses due to dishonest acts.
3. Opportunity Cost: Opportunity costs are those which results from the inability of the firm to respond to new opportunities. The management faces difficulties in seizing profitable investment opportunities due to organizational structure, hierarchy etc.
4. Capital structure expenditure: Capital structuring expenditure relates to structuring managerial compensation to maximize owner’s wealth.
   It is two types
   
   1. Incentive plan: The most widely used plan is stock option which allows management to acquire share at special prices. Higher price will result in larger management compensation.
   2. Performance Plan: These plans compensate management on the basis of its proven performances. Performance shares are given to management for meeting to stated goals. Another type cash bonus – cash payments are given for achievement of the stated performance goals.