Definition
Agency Cost refers to the economic costs that arise when an agent (such as a manager or employee) is hired to act on behalf of a principal (such as an owner or shareholder) but may pursue their own interests instead of the principal’s objectives.
Why It Matters
Agency costs affect corporations, governments, and financial institutions because decision-makers often control resources they do not personally own. Organizations therefore spend money on oversight, auditing, performance incentives, contracts, and governance systems to reduce conflicts of interest and ensure aligned decision-making.
Example
If company executives spend corporate funds on luxury offices or personal perks rather than productive investments, shareholders bear the loss. The company may respond by hiring auditors, tying executive pay to performance, or strengthening board oversight — all of which represent agency costs.