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problem: Central to the theory of agency is the notion that company will use optimal levels of contracting, monitoring & bonding to reduce agency costs. However, there are other ways by which agency value may be controlled.

[A] Since total agency costs rise with the level of outside financing, & company value is maximized when agency expenses are minimized, a simple method of eliminating agency expenses is to only use internal financing. Why would the original owner [entrepreneur] ever use outside financing?

[B] Think a world where the assumptions of the Capital Asset Pricing Model hold. Determine how are agency costs controlled in a ‘CAPM world’?

[C] How can the financial markets decrease the total agency costs of the company?

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