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hello sir,
as far as ive known agency costs are basically monitoring costs but i was having little trouble applying that concept when i was studying agency effects on capital structure,
i was told by my tutor that agency costs of debt are bankruptcy related costs and agency costs of equity are issue costs and monitoring costs of new shareholders and that the optimal structure is where cost of debt= benefits of debt, i couldn’t
understand
1. do u agree with the agency costs my tutor told me? if u do can u explain them to me that how are they agency costs
2. cost of debt= benefits of debt , how is this the optimal structure,thanks alot
If you are quoting your tutor correctly then I don’t agree with what he/she has said.
Agency costs are costs resulting from using an agent i.e. having the directors make decisions on behalf of the shareholders. The interests of the directors may not always coincide with what is in the best interest of shareholders.To says optimal structure is where cost of debt = benefits of debt does not make sense. The optimal structure is where the WACC is at a minimum and this is explained in full in our free lecture notes and the lectures that go with them.
So sir u r saying that they are no agency effects on capital structures? and if they are what is the optimal structure then?I was doing this theory along with others like pecking order etc and this came up made no sense to me as well
The main relevance of agency costs to capital structure is that management can have an incentive to accept risky projects because if the project is successful then shareholders get the benefit whereas if it is not successful then debt lenders could suffer. This can increase the risk of the business as a while.
So sir the restrictive conditions that debt holders may apply on taking up risky projects can that be included in agency costs
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