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CMA Foundation · Fundamentals of Business Economics and Management · Stewardship Theory and Agency Theory of Management

Shareholders of a company pay an outside firm every year to audit the accounts prepared by the managers, so that misreporting can be detected. In agency theory this expense is best classified as a:

The audit fee is a monitoring cost. Monitoring costs are expenses the principal bears to observe, check and control the agent's behaviour, such as audits and reporting systems. They differ from bonding costs, which the agent bears, and from residual loss, which remains after both.

  1. AResidual loss
  2. BBonding cost
  3. CMonitoring costCorrect
  4. DOpportunity cost of equity

Explanation

Monitoring costs are incurred by the principal to observe and check the agent's behaviour, and audit fees paid by owners are a standard example. Bonding costs are borne by the agent to assure the principal. Residual loss is the leftover loss in value even after monitoring and bonding.

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