In the context of agency theory, what do agency costs signify?

Agency costs signify the costs associated with addressing agency problems that arise from the relationship between principals (owners) and agents (managers). In agency theory, a fundamental concern is that the interests of the principals and agents may not always align, leading to potential conflicts of interest. These conflicts can lead to inefficiencies and misalignment of goals, which necessitates the implementation of measures to reduce these discrepancies.

To mitigate the impacts of agency problems, organizations may incur various costs, such as those related to monitoring agent behavior, implementing incentive structures, or hiring external watchdogs. These expenses aim to ensure that agents act in the best interest of the principals, thereby creating balance and accountability within the organizational framework. Therefore, the costs linked to these measures are referred to as agency costs, encapsulating the financial implications involved in managing the principal-agent relationship effectively.