The need to monitor management actions is an example of a(n) (direct/indirect) agency cost. Which type of agency cost does this represent?

• A. Direct agency cost
• B. Sunk cost
• C. Opportunity cost
• D. Indirect agency cost

Answer: (A)

Verified step by step guidance

1. Understand the concept of agency costs: Agency costs arise due to conflicts of interest between principals (owners/shareholders) and agents (management). These costs are incurred to ensure that agents act in the best interest of principals.
2. Differentiate between direct and indirect agency costs: Direct agency costs are expenses directly incurred to monitor and control management actions, such as audit fees or compliance costs. Indirect agency costs refer to lost opportunities or inefficiencies caused by management not acting in the best interest of shareholders.
3. Analyze the problem statement: The need to monitor management actions implies that resources are being spent to oversee and ensure proper behavior, which aligns with the definition of direct agency costs.
4. Clarify the other terms: Sunk costs are past costs that cannot be recovered and are irrelevant to future decisions. Opportunity costs represent the value of the next best alternative foregone. Indirect agency costs, as mentioned earlier, are inefficiencies or lost opportunities due to misaligned interests.
5. Conclude the type of agency cost: Based on the explanation, monitoring management actions is a direct agency cost because it involves explicit expenses to oversee management behavior.