The Main Agency Problems and Their Consequences

Abstract

The main aim of the paper is to present the most important conflicts of interest between “agents and principals” as well as the mechanisms for limiting these conflicts. The reduc- tion of free cash flow through the use of debt, and the use of protective bond covenants, are important means of reducing agency costs. It is pointed out that new equity dilutes the hold- ings of managers with equity interests, increasing their motive to waste resources, while debt reduces free cash flow, and the opportunity for managers to waste resources. Various types of protective covenants are presented in the paper. Because shareholders must pay higher interest rates as insurance against their own selfish strategies they frequently make agreements with bondholders in the hope of paying lower interest rates. These agreements are incorporated as part of the loan document between shareholders and bondholders. These protective covenants should reduce the costs of bankruptcy and ultimately increase the value of the firm.