How the use of high leverage levels can help mitigate agency costs of equity?
This argument is known as the agency costs hypothesis. Higher leverage may reduce agency costs through the monitoring activities by debt holders (Ang et al., 2000), the threat of liquidation which may cause managers to lose reputation, salaries, etc.
What are the costs of agency problems to an organization?
Agency costs are a type of internal cost that a principal may incur as a result of the agency problem. They include the costs of any inefficiencies that may arise from employing an agent to take on a task, along with the costs associated with managing the principal-agent relationship and resolving differing priorities.
What is agency cost theory?
An agency cost is a type of internal company expense, which comes from the actions of an agent acting on behalf of a principal. Agency costs typically arise in the wake of core inefficiencies, dissatisfactions, and disruptions, such as conflicts of interest between shareholders and management.
How can agency costs be mitigated?
The most common way of reducing agency costs in a principal-agent relationship is to implement an incentives scheme. Financial incentives based on performance help motivate agents to act in the best interest of the company. Examples of financial incentives are: Stock options.
How can leverage be used to mitigate agency costs?
Using multivariate and univariate analysis, their results confirmed that agency cost is negatively related to leverage. Increased debt in a business reduces agency costs by limiting discretionary cash flow available to managers and close monitoring by debt-holders (Banchit et al., 2013).
What are the three types of agency costs?
There are three common types of agency costs: monitoring, bonding, and residual loss.
What are the factors affecting cost of capital?
Fundamental Factors affecting Cost of Capital
- Market Opportunity.
- Capital Provider’s Preferences.
- Risk.
- Inflation.
- Federal Reserve Policy.
- Federal Budget Deficit or Surplus.
- Trade Activity.
- Foreign Trade Surpluses or Deficits.
What are the factors affecting capital structure?
Factors Affecting Capital Structure Decisions – General Factors to Consider in Order to Frame a Capital Structure Decision
- Leverage or trading on equity, effect on earnings per share.
- Growth and stability of sales.
- Cost of capital.
- Cash flow capacity of the firm.
- Control.
- Flexibility.
- Size of the firm.
How do you mitigate agency costs?
The most common way of reducing agency costs in a principal-agent relationship is to implement an incentives scheme. There are two types of incentives: financial and non-financial.
What is agency theory of capital structure?
Accordingly to the agency theory, the optimal financial structure of the capital results from a compromise between various funding options (own funds or loans) that allow the reconciliation of conflicts of interests between the capital suppliers (shareholders and creditors) and managers.
What are the two types of agency costs?
Agency costs can be broadly classified into two types: Direct and Indirect Agency costs.