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CMA Intermediate · Financial Management and Business Data Analytics · Introduction to Financial Management

Which of the following best describes the 'bonding cost' component of agency costs in the Jensen and Meckling framework?

Bonding costs are expenses the managers (agents) incur to assure shareholders that they will not act against shareholder interests, such as agreeing to covenants or reporting commitments. Auditor fees are monitoring costs, and the value lost despite these safeguards is the residual loss.

  1. AExpenditure incurred by managers to guarantee they will not take actions harmful to shareholdersCorrect
  2. BFees paid by shareholders to an external auditor for verifying accounts
  3. CThe loss in firm value that remains even after monitoring and bonding are in place
  4. DInterest paid to debenture holders for lending funds to the company

Explanation

Agency costs have three parts: monitoring costs borne by the principal, bonding costs borne by the agent, and the residual loss. Bonding costs are spent by managers to assure shareholders that they will act in their interest. Auditor fees are monitoring costs, and the leftover value loss is the residual loss.

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