net agency costs of equity

Agency costs

• Equity holders' cost to monitor the firm's executives, management's bonding costs to assure owners that their best interests are guiding the company's actions, and residual losses that result even when sufficient monitoring and bonding exists.

Adding additional debt reduces the agency costs to equity holders since less of their capital is at risk. The leverage effectively shifts some of the agency costs to bondholders. Additionally, managers have less cash to squander when higher leverage is employed since higher interest costs will restrict discretionary free cash flow.