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CA Intermediate · Financial Management and Strategic Management · Scope and Objectives of Financial Management

In the agency relationship between a company's shareholders and its managers, which of the following is an example of an agency cost that arises because managers may not always act in the interest of shareholders?

Expenditure on audits and monitoring systems to check managerial behaviour is an agency cost, specifically a monitoring cost incurred by shareholders to ensure managers act in their interest. Dividends, debenture interest and depreciation are normal payments or charges and do not arise from agency conflicts.

  1. AExpenditure on audits and monitoring systems to check managerial behaviourCorrect
  2. BDividend paid to shareholders out of profits
  3. CInterest paid on debentures issued to raise funds
  4. DDepreciation charged on plant and machinery

Explanation

Agency costs arise from conflicts between principals and agents and include monitoring costs, bonding costs and residual loss. Audit and monitoring expenditure is a monitoring cost. Dividends, interest and depreciation are ordinary returns or accounting charges, not costs of resolving a conflict of interest.

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