Agency cost is an economic concept that refers to the costs associated with the relationship between a "principal" and an "agent". The agent is given powers to make decisions on behalf of the principal, but the two parties may have different interests, leading to conflicts of interest. The costs associated with resolving these conflicts are known as agency costs.
In a business context, agency costs can arise due to conflicts of interest between shareholders and management. For example, shareholders may want management to run the company in a certain manner to increase shareholder value, but management may have different priorities. These differences in viewpoint can lead to substantial additional costs or the loss of value.
There are different types of agency costs, including labor agency costs, which arise when there is a conflict of interest between employers and employees. Other stakeholders such as the government, suppliers, and customers may also have their specific interests to look after, which might incur additional costs.
To reduce agency costs, companies can implement measures such as aligning the interests of the agent with those of the principal, monitoring the agents actions, and providing incentives for good performance.
In summary, agency cost is the cost incurred due to disagreements between the principal and the agent, where the principal does not have complete control over the situation. These costs can arise in various contexts, including business and government, and can be reduced by implementing measures to align the interests of the agent with those of the principal.
