Agency costs

Agency costs are the costs associated with the differences between the intentions of an agent and a principal, where the principal does not have complete control over the situation. For example, shareholders may want to increase earnings per share by focusing on cost cutting, while managers are more intent on spending money to increase their perks. Another relationship that can result in agency costs is between elected politicians and voters, where politicians may take actions that are detrimental to the interests of voters.

These differences in viewpoint can lead to substantial additional costs or the loss of value. For example, when the managers of a company take the business in a direction that is disagreeable to shareholders, the shareholders are more likely to sell off their shares in the business, which reduces the market value of the shares. This decline in value is an agency cost.