Definition of 'Agency Costs' A type of internal cost that arises from, or must be paid to, an agent acting on behalf

of a principal. Agency costs arise because of core problems such as conflicts of interest between shareholders and management. Shareholders wish for management to run the company in a way that increases shareholder value. But management may wish to grow the company in ways that maximize their personal power and wealth that may not be in the best interests of shareholders. 'Agency Costs' Some common examples of the principal-agent relationship include: management (agent) and shareholders (principal), or politicians (agent) and voters (principal). Agency costs are inevitable within an organization whenever the principals are not completely in charge; the costs can usually be best spent on providing proper material incentives (such as performance bonuses and stock options) and moral incentives for agents to properly execute their duties, thereby aligning the interests of principals (owners) and agents. The costs consist of two main sources: 1. The costs inherently associated with using an agent (e.g., the risk that agents will use organizational resource for their own benefit) and 2. The costs of techniques used to mitigate the problems associated with using an agent gathering more information on what the agent is doing (e.g., the costs of producing financial statements) or employing mechanisms to align the interests of the agent with those of the principal (e.g. compensating executives with equity payment such as stock options).