Agency Costs in Capital Structure Decisions

Easy Capital Structure Decisions Agency Costs

In the context of corporate finance, agency costs arise from the conflicts of interest between stakeholders, particularly between management (agents) and shareholders (principals). One of the ways to mitigate these costs is through capital structure decisions. Consider a company that is evaluating whether to finance a new project with debt or equity. Analyze the potential implications of each financing option on agency costs.

Debt financing generally increases agency costs because debt holders have less control over management decisions.

Equity financing reduces agency costs as it aligns the interests of management with those of the shareholders.

Debt financing reduces agency costs by imposing discipline on management through mandatory interest payments.

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