Introduction to DQ6This DQ goes all the way back to some of the initial parts of this course to the Contents section of M1.To get us going, lenders are not involved in the day-to-day operations and business decisions made by the owners in running their businesses. Also, owners may not be making decisions, both short- and long-term, which are in the best interest of their lender(s) or that might affect a lender’s decision with regards to lending money to a business (or its owners). Hence, the agency problem that exists in this type of relationship.How Do Lenders Cause Firms to Incur Agency Costs?So, for example (and there are others), lenders often put financial covenants into their loan agreements with firms in order to protect their ability to recover the loan in the future. Another covenant the lender may put in the loan agreement is that the firm must hire an independent auditor to certify not only the financial statements in a regular audit but also the calculations made supporting any financial covenants placed in the loan agreement.Examples of Agency Costs Imposed by Lenders
-the loan agreement will contain financial covenants in it that the Company must meet every month, or every quarter, or every year
-the Company must submit a document to the Lender, showing that they have complied with the financial covenants in the loan agreement, signed by the executive officers of the company
-the Company may be required to engage and pay for an independent audit of the Company’s financial statements, including auditing the Company’s calculations of the financial covenants contained in the loan agreement
-or, the Lender may have the right, at the Company’s expense, to send in its own auditors into the Company to audit the Company’s calculations made of the financial covenants contained in the loan agreement
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