Understanding Agency Costs in Capital Structure

Very Easy Capital Structure Decisions Agency Costs

ABC Corporation is a mid-sized manufacturing firm with a stable revenue stream. The management team believes that their level of debt is optimal, given the company's consistent cash flows, but they are concerned about the potential agency costs associated with their current capital structure. Agency costs arise when there's a conflict of interest between stakeholders, particularly between shareholders and managers.

Which of the following statements best describes the agency costs related to capital structure that ABC Corporation might face?

Higher levels of debt can reduce agency costs by aligning the interests of managers and shareholders.

Increased equity in the capital structure can lead to higher agency costs between shareholders and management.

Agency costs only arise in firms with high levels of leverage.

Hint

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