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

Under the agency problem in a company, which of the following is an example of an agency cost borne by shareholders to restrain managers from acting against their interests?

Auditor fees and the cost of monitoring through board committees are agency costs. They are incurred by shareholders to ensure managers act in the owners' interest. Dividend payments, bonus issues and trade credit are routine financial decisions, not costs of resolving the principal-agent conflict.

  1. AFees paid to an auditor and the cost of monitoring through a board committeeCorrect
  2. BDividend paid out of the current year's profits
  3. CIssue of bonus shares to existing shareholders
  4. DPurchase of raw materials on credit from suppliers

Explanation

Agency costs include monitoring costs, such as audit fees and oversight mechanisms, incurred to ensure managers act in shareholders' interests. Dividend, bonus issue and trade credit are ordinary financial decisions and are not costs of controlling the conflict between principals and agents.

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