A General Overview On Examples Of Agency Costs : What You Need To Know
Agency costs are a type of internal business spending that usually happens when there are major problems or disappointments.
Agency costs are the costs that come from an agent doing something on behalf of a principal. They can be either explicit or implicit.
In this blog post, we'll look at some examples of agency costs that have been seen in many different industries and explain in detail how to avoid them in your own business model.
Agency costs are an internal cost that a company has to pay because of what an agent does on behalf of a principal.
Most agency costs are caused by fundamental problems, dissatisfaction, and disruptions, such as when investors and management have different goals.
There are two types of agency costs:
Costs Direct Â
Direct Agency Cost: Direct agency costs are agency costs that can be directly linked to a certain agent-principal contact.
A direct agency cost is what happens when an employee uses company resources for his or her own personal gain.
Indirect agency cost:
It's harder to keep track of indirect agency costs, and there's often more uncertainty about them.
Usually, these costs happen when the interests of the agent and the principal are not the same.
An example of an indirect agency cost is when the top management of a company gets paid a lot even though the company isn't doing well.
Examples of agency costs:
Overcompensation: When top executives are paid too much for bad work, this is an example of an indirect agency cost.
When an agent works for a principal and takes advantage of the chance to earn more money or a bigger bonus than they should get based on their job requirements and duties, they are committing an act of unjustified compensation.
In this case, it's clear that the shareholders' needs aren't being met because the management is making decisions for themselves instead of for everyone.
The most common example of agency costs is when company executives use company resources for their own benefit. This can lead to direct agency costs, such as when they buy expensive clothes with company credit cards or use free hotel rooms after staying late at work.
2) Misaligned interests:
Misaligned interest is when the agents and principals of a company don't have the same goals.
It happens when top management gets paid a lot even though they didn't do a good job in their positions or departments.
When managers don't look out for the best interests of shareholders by maximizing profit margins, it can cost the agency a lot of money in the form of lost revenue and other indirect costs.
An example of a corporate incentive that isn't set up right is when an insurance agent makes a deal with a client who has already accepted lower rates from another company, even though he knows that these rates don't come with any coverage benefits.
Another type of direct agency cost is self-dealing.
It means that an agent uses their position in the company to unfairly help themselves or someone close to them, like a friend or family member, financially.
Another example is if the CEO hires his son as a high-paying executive and gives him special privileges and benefits that other employees don't have.
A conflict of interest could happen when an agent buys something or gets a service from a company in which the agent has a stake.
In either case, it's clear that personal gain takes precedence over what's best for the company as a whole.
4) Inefficient decisions:
Inefficient ways of making decisions can sometimes cause agency costs.
When management isn't held responsible for what they do and is free to make bad decisions without being punished, it can lead to a lot of costs for the agency itself.
For instance, mistakes are made over and over again, and chances to save money are missed because no one in the company has the power to make decisions that could improve financial performance.
5) Organizational disruptions:
Finally, agency costs can also be caused by disruptions to the organization.
Exceptional events are things that happen that make it hard for a company to run its daily business, like when a manager quits or is fired without enough notice.
This can lead to more confusion and higher costs as employees try to take over their former employer's duties and responsibilities.
- Regulatory problems:
Agency costs can be helpful, like when it comes to keeping employees and managers motivated, but they can also be bad.
Examples of this type of agency cost are the ones listed above, which all lead to internal company costs that are not in the best interests of shareholders.
When these kinds of situations happen often or even just once over a period of years, companies may start getting in trouble with the law because their agencies aren't following the rules.
- Loss of productivity:
Examples of agency costs can lead to more inefficiency and less work getting done, which causes prices to go up for customers.
This makes it harder to compete with other companies whose operations or departments don't have these problems.
Because of this, the company may miss out on good business opportunities because it can't offer lower rates than its competitors, even though it has higher operating margins because it has lower agency costs.
Last, agency costs can make it harder for a company to be flexible with its money.
When management cares more about its own interests than those of the shareholders, it may stop the company from issuing new shares of stock or debt securities to raise money.
This cuts down on the amount of money that can be put back into the business, which hurts its ability to grow and compete in some markets.
Reason for Agency Costs:
- There are examples of agency costs in companies because the people at the top aren't open and accountable.
- If there are too many secrets or if management has too much power, it can lead to corruption.
- This problem usually happens when shareholders don't know enough about how their company works internally and how decisions are made.
- When this happens, agents can use their positions to their own benefit and run the company into the ground.
- Agency costs examples are often seen as bad parts of running a business, but they can also be seen as a way to encourage employees and managers to do their best work.
- However, this is only possible if companies have systems in place to ensure that these examples are limited and kept under control.
- If there isn't any oversight, management can use their power to take advantage of employees for their own gain or let problems in the way the company works go unfixed.
- This often makes the whole organization less productive and increases internal costs, which is against the interests of the shareholders.
There are different types of agency costs that come from different things going on inside a company.
It's important for management to know what their jobs are and take responsibility for them if they don't want these problems to happen, since they can hurt the value of the company over time.