Explain the term “agency costs” and give any three examples of such costs.

CPA-Financial-Management-Section-3 Revision kit

Agency costs
These are cost borne by shareholders of an organization as a result of not being directly involved in decision making, when the decisions are made by the directors. Agency costs are incurred when management decisions are based on the interests of directors rather than shareholders.

Examples of agency costs.

(i) Expenditure for external audit incurred by the organization

(ii) Installation of systems of internal control and internal audit

(iii) Opportunity costs of foregone projects which are perceived by management to be too risky.

(iv) „Perks” and incentives paid by the organization to make directors act the best interests of shareholders.

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