board of directors and/or management do not act in the best interests of the
shareholders, the firm incurs agency costs, which are borne by the shareholders
in the form of a lower stock price.
The shareholders are represented by an elected board of directors, which in turn hires management to operate the company. The board should always put the shareholders first and try to get management to act in the best interests of the shareholders and not the best interests of management or the board. In some companies, however, the board and management fail to act in the shareholders’ best interests, and the shareholders bear these agency costs, which keeps the price of the stock lower than what it otherwise would be. Nearly all companies have some agency costs, but some have much more than others.
The relationship between the shareholders, the board of directors, and management is called corporate governance. When boards properly represent shareholders, a company is said to have good corporate governance.
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Last updated: January 9, 2011