2916 WordsOct 18, 199912 Pages

The quote shows a strong relation to the efficient market hypothesis (EMH), as it implies that the costs of capital are dependent from the amount of information given by the company. According to my opinion, agency theory is a good explanation for costs of capital. Agency theory defines contracts as under which one party – called principal – engages another party – called the agent – to perform service on the principal’s behalf. Concluding, the principal delegates decision-making authority to the agent. Both sides of the contract are utility maximisers and the agent will not necessarily act in the principal’s best interests. This leads to the rise of agency costs. Agency costs are the welfare*…show more content…*

Then, comparability of information needs an explanation. This leads into either one standard for accounting procedures or different standards with firms obliged to mention which standard they have chosen. In the past, business fought constantly against the uniformation of standards and the problem of the latter suggestion is that it needs skilled users to evaluate the impact of the different standards on the financial statement. As only a limited group will be able to do this, the number of possible financers is reduced. Capital could become more expensive since in free market systems a broader supply of capital should result into lower prices for capital and the reverse effect is true. Further, accounting has difficulties to clearly measure performance and the value of assets. Therefore, many different methods exist as historical cost, present value, current replacement costs, net realisable value, and deprival value accounting and all are reasonable in their approaches. Trust of the public means more trust in managements’ behaviour. This is reflected in less monitoring and reduced bonding costs. The former reduction is obvious and with good experience in more trustworthy relationships the monitoring mechanisms should decrease. As these costs decrease, so should the costs of capital decrease caused by a decrease of interest expense or dividend payout. A capital market’s development is dependent from investors’ trust

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