CMA Foundation · Fundamentals of Business Economics and Management · Stewardship Theory and Agency Theory of Management
Shareholders of Bharat Auto Ltd. fear that managers might expand the firm just to enlarge their own empire. They spend ₹12 lakh on monitoring (audit and board oversight) and ₹8 lakh on a bonus scheme linked to profit, and still estimate a ₹5 lakh loss from decisions that diverge from owners' interest. What is the total agency cost?
Total agency cost is ₹25 lakh. It is the sum of monitoring expenditure of ₹12 lakh, the incentive or bonding cost of ₹8 lakh and the residual loss of ₹5 lakh from divergent decisions. Omitting the residual loss gives only ₹20 lakh, which understates the cost.
- A₹20 lakh
- B₹17 lakh
- C₹25 lakhCorrect
- D₹13 lakh
Explanation
Agency cost = monitoring costs + bonding/incentive costs + residual loss. Total = 12 + 8 + 5 = ₹25 lakh. Leaving out the residual loss gives ₹20 lakh, which is the key mistake.
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