[Corporate Finance] Agency Cost Of Outside Equity

A few days ago i am revising Corporate Finance subject for my exam. Upon reading, i encountered a concept called Agency Cost of Outside Equity by Fama and French. At first, i think their explanation was quite plausible and logical. But as i went on to think about this concept, something feels quite "un-appropriate" for me personally.


Agency Cost is generally associated with the cost of an agent acting on his or her own will.

Agency Cost of Outside equity as described by Fama and French is the result of "slacking" by managers because they perceived their efforts are not well recognized in terms of monetary means.

Managers works to increase the firms value by incurring cost of efforts to them but because the equity of the firm was also held by outsider (outside equity), they only get a portion of their efforts' results. This, in turns, induces managers to lower their efforts in increasing firms value.

The solution that was given, is that managers can buy out those outside equity using debt financing hence increasing their proportion of equity in the firm.

To me, managers wouldn't have slacked around because they only hold a small proportion of the equity and only gets a small proportion of the rewards (i.e. dividends). The rationale behind this is that, managers have salary which induces them to manage the company well. And if they do it very well, they can claim bonuses which is decided by them too. This salary and bonuses is the cost of efforts that the managers can recoup as a result of being in the position to manage firms.

I personally think, there's little or probably no agency cost of outside equity.

On the opposite side, i think there's an agency cost of inside equity where managers claims extravagant bonuses.