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Encyclopedia > Agency cost

An agency cost is the cost incurred by an organization that are associated with problems such as divergent management-shareholder objectives and information asymmetry. Management (from Old French ménagement the art of conducting, directing, from Latin manu agere to lead by the hand) characterises the process of leading and directing all or part of an organization, often a business, through the deployment and manipulation of resources (human, financial, material, intellectual or intangible). ... A shareholder or stockholder is an individual or company (including a corporation), that legally owns one or more shares of stock in a joint stock company. ... In economics, information asymmetry occurs when one party to a transaction has more or better information than the other party. ...


The information asymmetry that exists between shareholders and the Chief Executive Officer is generally considered to be a classic example of a principal-agent problem. The agent (the manager) is working on behalf of the principal (the shareholders), who does not observe the actions of the agent. This information asymmetry causes the agency problems of moral hazard and adverse selection. Chief Executive Officer (CEO) is the job of having the ultimate executive responsibility or authority within an organization or corporation. ... In economics, the principal-agent problem in economics treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. ... In law and economics, moral hazard is the name given to the risk that one party to a contract can change their behaviour to the detriment of the other party once the contract has been concluded. ... Adverse selection or anti-selection is a term used in economics and insurance. ...


These costs were first identified by Michael Jensen and William Meckling in 1976.


 
 

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