CMA Foundation · Fundamentals of Business Economics and Management · Stewardship Theory and Agency Theory of Management
Shareholders of Arjun Steels Ltd. incur the following costs to reduce the agency problem: audit fees Rs 4 lakh, cost of bonding the manager through insurance guarantees Rs 2 lakh, and the estimated loss in firm value of Rs 3 lakh because the manager still makes some decisions that are not value-maximising. Total agency cost is:
Total agency cost is Rs 9 lakh. Agency cost is the sum of monitoring costs (Rs 4 lakh audit), bonding costs (Rs 2 lakh) and residual loss (Rs 3 lakh). Leaving out the residual loss would understate the cost at Rs 6 lakh.
- ARs 6 lakh
- BRs 7 lakh
- CRs 9 lakhCorrect
- DRs 5 lakh
Explanation
Agency costs comprise monitoring costs (Rs 4 lakh), bonding costs (Rs 2 lakh) and residual loss (Rs 3 lakh). Total = 4 + 2 + 3 = Rs 9 lakh. Rs 6 lakh wrongly omits the residual loss, and Rs 7 lakh omits the bonding cost... Rs 5 lakh omits monitoring partly and is wrong.
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