Strategic Business Leader · Agency

Agency Problem and Agency Costs in ACCA SBL

Updated 11 October 2026 · Fact-checked

The agency problem arises when an agent (such as a director) acts for a principal (such as a shareholder) but pursues their own interests. It is made worse by information asymmetry and moral hazard. Agency costs are monitoring costs, bonding costs and the residual loss that remains. In SBL, apply each to the case facts.

Understand Agency Problem and Agency Costs

An agency relationship exists when a principal hires an agent to act on their behalf and gives the agent some decision-making authority. The classic SBL case is shareholders (principals) and directors (agents). Shareholders own the company but directors run it day to day.

The agency problem is the conflict that follows. The agent's interests may differ from the principal's. Shareholders usually want long-term growth in value. Directors may want higher pay, bigger perks, job security, empire building or a quiet life. The agent may then make decisions that help themselves at the principal's expense.

Two ideas explain why the problem persists. Information asymmetry means the agent knows more about the business than the principal does, so the principal cannot easily judge whether the agent is acting well. Moral hazard means the agent can take decisions or risks, or put in less effort, because the principal bears much of the consequence. Moral hazard is a behaviour. Information asymmetry is the condition that allows it. Do not treat them as the same thing.

The problem is costly to manage, and these are the agency costs. Monitoring costs are borne by the principal to watch the agent, such as audits, board oversight, reporting requirements and non-executive directors. Bonding costs are borne by the agent to show they can be trusted, such as contractual commitments, accepting performance targets or providing regular reports. Residual loss is the value still lost after monitoring and bonding, because no control is perfect.

In the exam, the point is not to recite definitions. You must link them to the scenario: who is the principal, who is the agent, what is the conflict, what evidence shows it, and what can be done about it at reasonable cost.

Key rules to remember

Agency relationship: Principal → delegates authority → Agent; Identify both parties from the scenario. Shareholders and directors is common, but directors and managers, or lenders and the company, can also fit.
Total agency costs: Agency costs = monitoring costs + bonding costs + residual loss; Monitoring is borne by the principal. Bonding is borne by the agent. Residual loss is the value lost that remains despite both.
Causes of the problem: Divergent interests + information asymmetry + moral hazard; Divergent interests create the conflict. Information asymmetry and moral hazard let it continue.

How to solve Agency Problem and Agency Costs questions

Use this method for any SBL requirement on the agency problem, whether it asks you to explain, assess or recommend.

1Read the requirement and note the verb: explain, discuss, evaluate or recommend. It sets the depth.
2Identify the principal and the agent in the scenario. Name them specifically, not generically.
3State how their interests differ, using evidence from the case, such as pay, bonuses, expansion plans or lack of disclosure.
4Explain the enabling factors: where the agent knows more (information asymmetry) and where the agent bears less risk (moral hazard).
5Classify the costs: monitoring, bonding and residual loss, with a case example of each where you can.
6If the requirement asks for solutions, propose controls such as non-executive directors, audit committees, remuneration linked to long-term performance, or disclosure, and weigh their cost against their benefit.
7Conclude with a judgement on how serious the problem is and which action matters most.
8Check that each point is tied to the scenario and not just theory, since professional skills marks reward application and judgement.

Quickest way: P-A-C-F-S under time pressure

When to use it: Use when you have about 10 minutes for a 10 to 15 mark agency requirement.

P: name the principal and agent from the case.
A: state the conflict of interest with one piece of case evidence.
C: explain the cause, either information asymmetry or moral hazard, with an example.
F: list the three costs, monitoring, bonding and residual, with a case example for each.
S: give two or three solutions and a one-line judgement on cost versus benefit.

Common mistakes in Agency Problem and Agency Costs

Treating agency problem and moral hazard as the same thing.
Both involve an agent acting against the principal, so they seem identical.
Fix: Say the agency problem is the overall conflict. Moral hazard is one behaviour within it, where the agent takes risk or lowers effort because someone else bears the cost.
Giving only textbook definitions of the three agency costs.
Students memorise the list and stop there.
Fix: For each cost, give an example from the scenario, such as an external audit as monitoring or a director shareholding commitment as bonding.
Assigning monitoring costs to the agent.
Students confuse who pays for which cost.
Fix: Remember that the principal monitors and pays. The agent bonds and pays. Residual loss is what remains.
Assuming agency costs can be removed.
Students propose controls as if they solve everything.
Fix: Point out that controls themselves cost money and residual loss always remains. Aim to balance cost and benefit.
Only discussing shareholders and directors.
It is the most familiar example.
Fix: Check whether the case shows other relationships, such as directors and managers, or the company and lenders, and use the one that fits.
Listing points without a conclusion or recommendation.
Students run out of time or forget the professional skills marks.
Fix: End with a short judgement and a clear recommendation, supported by the case facts.

Worked examples

Example 1

Zenara Ltd is owned by 4,000 outside shareholders. The chief executive receives a fixed salary plus a large annual bonus based on revenue. Over three years the CEO has acquired five loss-making businesses to increase revenue. Board papers on the acquisitions were brief and shareholders received little detail. Explain the agency problem at Zenara and identify the causes. (10 marks)

Show the solution

Identify the parties: shareholders are the principals and the CEO is the agent, with delegated authority over strategy.
Show the conflict: shareholders want long-term value. The CEO is paid a bonus on revenue, so gains from growth even when acquisitions lose money. This is divergent interest.
Information asymmetry: the CEO and management know the true performance of the acquisitions. Shareholders receive only brief papers, so they cannot judge the decisions properly.
Moral hazard: the bonus is not reduced by losses, so the CEO bears little of the downside while shareholders bear the cost of the poor acquisitions.
Conclude: the revenue-based bonus is a poor incentive and disclosure is weak. These are the main issues to address.

Answer: The principals are the shareholders and the agent is the CEO. The CEO's revenue-based bonus encourages acquisitions that increase revenue but destroy value, which conflicts with shareholders' interest. Information asymmetry arises because shareholders receive little detail. Moral hazard arises because the CEO is rewarded for growth without bearing the losses. The incentive scheme and disclosure both need review.

Example 2

Following the problems at Zenara Ltd, the board proposes (i) appointing more non-executive directors and an audit committee, and (ii) requiring the CEO to hold shares in the company and report quarterly on acquisitions. Classify these as agency costs and evaluate them. (10 marks)

Show the solution

Classify (i): non-executive directors and an audit committee oversee the CEO on behalf of shareholders. They are paid for by the company, so this is a monitoring cost borne ultimately by the principal.
Classify (ii) shareholding: the CEO accepting a stake ties their wealth to share price. This is a bonding cost, because the agent commits to align with shareholders and gives up some diversification.
Classify (ii) quarterly reporting: the CEO commits to regular disclosure. This is also a bonding cost, though it reduces information asymmetry.
Evaluate: monitoring reduces opportunistic behaviour, but it costs fees and management time. Bonding aligns interests, but the CEO may demand higher pay to compensate for the risk.
Residual loss: even with both measures, the CEO may still make some poor decisions or hide information, so some loss will remain.
Judgement: the shareholding is probably the most cost-effective because it changes incentives directly. Monitoring should supplement it, and the revenue-based bonus should also be replaced by a measure linked to long-term returns.

Answer: Non-executive directors and the audit committee are monitoring costs. The CEO shareholding and quarterly reporting are bonding costs. Both reduce the agency problem but have costs, and some residual loss will remain. The shareholding and a revised bonus linked to long-term returns are likely to be the most effective, with monitoring as support.

Exam tips

Always name the principal and agent from the case before using theory. Generic answers lose application marks.
Use the exact terms monitoring, bonding and residual loss, and give a scenario example for each.
Keep moral hazard and information asymmetry separate. Define each in one line and show it in the case.
When asked to recommend, weigh cost against benefit and give a clear judgement. This earns professional skills marks.
Link agency to related areas the case may raise, such as remuneration, board structure and governance codes.

Practice questions from Agency

Agency Problem and Agency Costs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Agency Problem and Agency Costs: frequently asked questions

What is the difference between the agency problem and moral hazard?

The agency problem is the broad conflict of interest between a principal and an agent. Moral hazard is one cause of it: the agent acts differently, for example takes more risk, because the principal bears the consequences. Information asymmetry is what makes this hard for the principal to detect.

What are the three types of agency costs?

They are monitoring costs, bonding costs and residual loss. Monitoring costs are paid by the principal to oversee the agent. Bonding costs are paid by the agent to assure the principal. Residual loss is the value still lost after both.

How do I explain the agency problem in an SBL answer?

Name the principal and agent in the case, then show how their interests differ using case evidence. Explain the role of information asymmetry or moral hazard, and then link to costs and solutions. Finish with a judgement.

Does the agency problem only apply to shareholders and directors?

No. It applies wherever one party delegates decisions to another. Other examples include directors and managers, or lenders and the company. Use whichever relationship the scenario shows.