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The quote shows a strong relation to the efficient market hypothesis EMH as it implies that the costs of capital are dependent from the amount of information given by the company According to my opinion agency theory is a good explanation for costs of capital Agency theory defines contracts as under which one party called principal engages another party called the agent to perform service on the principals behalf Concluding the principal delegates decision-making authority to the agent Both sides of the contract are utility maximisers and the agent will not necessarily act in the principals best interests This leads to the rise of agency costs Agency costs are the welfare reduction by the principal due to the divergence of the interest There are three agency costs 1 monitoring costs 2 bonding costs and 3 residual loss 1 Monitoring costs are the costs of monitoring agents behaviour They are expenses of the principal to measure observe and control the agents behaviour Good examples for monitoring costs are auditing costs To protect themselves of huge monitoring costs principals are bearing the costs to agents An example can be given in lending A high-risk company has high monitoring costs which leads to a high interest rate Another example would be the reputation of the manager Has he got a bad reputation than his salary would be lower than usual Agents try to reduce monitoring costs by installing mechanisms to guarantee that they will behave in the interest of the principal or by proposing to compensate principals for their losses 2 The mechanisms mentioned above are bonding costs because they are the costs of bonding the agents interest to the principals Quarterly financial reports are bonding costs namely the time and effort invested to generate the financial report Agents will normally weigh bonding costs with monitoring costs and chose the cheaper alternative 3 Despite bonding and monitoring costs it is still likely that agents interests will
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