Agency Costs Definition

Definition: This occurs when the interests of the principal (a company or people) conflict with the interests of the agent. The principal hires the agent to act on its behalf, but due to having different interests, it is not certain that the agent always acts for the principal’s best interests. These kind of conflicts, for example, arise between the shareholders of the company and its management. Shareholders wish for management to run the company in a way that increases shareholder value. But management may wish to grow the company in ways that maximize their personal power and wealth (with performance bonuses and stock options) that may not be in the best interests of shareholders. In order to minimize the agency costs, the principal can monitor what the agent does, or to make the interests of the agent more like those of itself.