Agency Cost Of Debt

An agency cost comes up when the interests of the managers of a company are different from the interests of the owners (See: Agency Cost).

One key example comes up in the decision whether or not to take on debt. For an owner or shareholder, taking on debt has the potential for highly negative consequences. Once in debt, their company owes that money to someone.

But managers don't face the same issues. For the managers, having large amounts of cash to spend is beneficial. They can take chances and grow the company, or maybe just pay themselves a large salary.

If things go south, the managers might lose their jobs, but it won't be their responsibility to repay the loans. That burden falls on the owners, who might be saddled with debt long after the managers have moved on to other jobs, or have retired to some tropical island famous for its mai-tais.

Thus the relative costs and benefits of taking on debt are different for managers than it is for the owners they work for. The managers are agents of the owners, theoretically working for them and promoting the owners' interest, but they might have their own ideas of what is the best course of action, just because the consequences don't hit everyone equally.