CMA Intermediate · Financial Management and Business Data Analytics · Introduction to Financial Management
A company's board pays Rs 40 lakh a year to an independent audit committee and monitoring systems. Managers separately spend Rs 10 lakh a year on additional disclosures to reassure investors. Despite this, managerial decisions still reduce firm value by Rs 25 lakh a year. What is the total annual agency cost?
Total agency cost is Rs 75 lakh, the sum of monitoring cost of Rs 40 lakh, bonding cost of Rs 10 lakh and residual loss of Rs 25 lakh. All three components must be included under the Jensen and Meckling definition.
- ARs 75 lakhCorrect
- BRs 65 lakh
- CRs 50 lakh
- DRs 35 lakh
Explanation
Total agency cost = monitoring (Rs 40 lakh) + bonding (Rs 10 lakh) + residual loss (Rs 25 lakh) = Rs 75 lakh. Rs 65 lakh omits bonding costs; Rs 50 lakh omits monitoring; Rs 35 lakh omits the residual loss.
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