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ABSTRACT
This paper provides a critical review on the relevance and impact of agency problems and its impact on the borrowing levels of firms. We provide a brief look at the fundamental theoretical predictions from a basic framework established in the literature. Furthermore, we discuss the implications of the conflicts between managers and shareholders as well as shareholders and debtholders. The empirical literature provides some interesting insights on the potential mechanisms that can be used to reduce agency problems which range from managerial incentives, concentration of shareholders as well as the level, nature and maturity of debt. The findings are however inconclusive on the ability of such mechanisms to effectively control agency problems and subsequently reduce agency costs. Thus the issues highlighted remain unresolved and leaves ample room for future researchers.
Keywords: Agency conflicts, shareholders' wealth, borrowing
INTRODUCTION
The literature in this area can be traced back to times of Adam Smith who noted that when 'joint-stock' companies were managed by people, who did not own them, there would be a conflict. This conflict is often referred to as the agency theory and describes the agent-principal relationship. In the modern corporation, the agent (the management) works on behalf of the principal (the shareholders) who does not have the capacity or means to scrutinise the actions of the agent, even if they had the incentive to do it. The problem that arises here is that there may be a conflict in the objectives of the managers and the owners. The owners would like to see the value of the firm maximised. Meanwhile, the management would be making decisions to fulfil their own set of objectives that may include a guarantee of their current job and position, reducing the workload by investing in projects that are less complicated or require less attention and also favouring projects that have lower payback period which could mean a more secure alternative.
Managers have every incentive to consume corporate wealth since the costs of such consumption is not borne by himself. Seminal work in this area that relates to corporate financing behaviour indicates that the principal can limit the divergences from his interests by providing appropriate incentives (Jensen and Meckling 1976). The principal would also have to incur monitoring...