Final answer:
The Agency Problem in finance is an issue that arises from conflicts between the goals of shareholders and those of managers. It encompasses direct and indirect agency costs. Decision-making regarding sourcing financial capital for a firm's growth often involves negotiating between the better-informed managers and outside investors.
Step-by-step explanation:
The concept known as the Agency Problem refers to the conflict of interest that arises when shareholders (or Principals) hire managers (or Agents) to run their company. All of the statements provided concerning the Agency Problem are true:
- It occurs when managers are appointed by shareholders to operate the firm on their behalf.
- A direct agency cost is incurred when managers use company funds for personal benefits rather than for the benefit of the shareholders.
- An indirect agency cost happens when managers avoid engaging in high risk, high return projects due to the potential personal costs to themselves, even if such projects might benefit shareholders.
Choices regarding financial capital for expansion in a firm with established financials are made in light of patterns explained by imperfect information. Managers have more intimate knowledge of the company's potential for profit than external investors, impacting decisions on whether to pursue debt financing via borrowing or equity financing by issuing stock.