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CFA Level I · CFA Level I Exam · Investors and Other Stakeholders

An external investor is concerned that a firm's manager, who owns little stock, consumes excessive perquisites such as private jets. Which mechanism is most likely to address this agency cost directly?

Monitoring by an independent board and expense audits most directly addresses it. These oversight mechanisms limit managers' ability to consume perquisites at shareholders' expense, reducing agency costs. Larger cash balances would give managers more discretion, and preferred shares for employees do not target the conflict.

  1. AMonitoring by an independent board and audit of expensesCorrect
  2. BIncreasing the firm's cash balances
  3. CIssuing additional debt-free preferred shares to employees

Explanation

Agency costs of perquisite consumption are controlled by monitoring and bonding, such as independent oversight and expense audits. Holding more cash gives managers more discretionary resources, and preferred shares to employees do not address it.

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