Agency Costs and Capital Structure Decisions

In the context of corporate finance, agency costs arise from the conflicts of interest between stakeholders, particularly between shareholders and management. Consider a hypothetical company, XYZ Corp, which has been adopting a highly leveraged capital structure. Recent studies suggest that the high levels of debt have led to significant agency costs due to potential risk-shifting behaviors among management. Management is incentivized to undertake risky investments that may maximize equity value, but simultaneously jeopardize the firm's viability, given that debt holders bear the consequences of such decisions.

Which of the following statements correctly identifies the impact of agency costs in XYZ Corp's capital structure decisions?