Jensen and Meckling (1976) refers to the costs that arise due to the use of an agent by a principal in an agency relationship as agency cost. These costs include (1) the costs of opportunistic behaviour by the agent (such as when the agent places his own self-interest over that of the principal’s), (2) the costs to the principal of monitoring the agent ; and (3) the “bonding” costs incurred by the agent to induce the principal to rely on it. Nonetheless, the opportunistic behaviour of the agent may work in the favour of principal when the agent contracts with other parties such as debtholder. This phenomenon has been explained as the agency cost of debt (Kim and Sorenson, 1986). Furthermore, Coffee, Jackson, Mitts and Bishop (2018) extend the agency cost argument to the relationship between the different types of shareholders associated with modern corporations. Specifically, Coffee et al., (2018) find that there is the tendency for strong and powerful shareholders to exploit less powerful shareholders. These empirical evidences suggest that any investor may be susceptible to some form of exploitation as result of the agency relationship and its associated agency problem.

Critically examine the following scenarios and state with explanation;

Whether an investor has a high, medium or low level of agency cost

The type of agency cost likely to be assume an investor

The type of corporate governance mechanism which would be appropriate in addressing the type of agency cost

Note: the following scenarios are independent of each other.

1) ABC Ltd, an Australian based firm is a large manufacturing firms with 25 subsidiaries which operates from different part of the world. On 30th July 2018, Birim Equity fund acquired an additional 25% of shares of ABC Ltd resulting in its total shareholding of 48%. The Herald Sun in its business segment described the acquisition as one which makes Birim Equity a dominant shareholder. How would this situation affect agency cost for prospective investor if

Birim Equity is separated from management

Birim Equity is not separated from management

2) Michael Bloomberg, a recent graduate of La Trobe University received $0.5 million cash as his inheritance after the death of his father. Michael has decided to invest his wealth in a listed firm which characterised by many shareholders with each shareholder having a small amount of shares

3) Tori, a small-time investor, has decided to invest in Dada PLC. Dada PLC has a large bank loan on its books.

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Agency relationship is a contract between two parties Principal and Agents Agents are engaged by Principal to perform some duties these agents are also assigned some decision making authority on behal... View the full answer