Ethical Accounting Practice Test 2026 – Complete Guide for C03 Exam Preparation

Agency costs arise from the conflict between owners and managers and the extra costs that result from trying to align interests. Monitoring managerial performance is a classic example, as owners incur expenses to observe and evaluate how managers run the company. Information asymmetry, including insiders knowing more about the company than outsiders, drives these costs because outsiders must spend resources to bridge that gap and verify actions and reports. However, developing internal controls over financial reporting is a governance mechanism designed to prevent or reduce misstatements and opportunistic behavior. It’s a proactive step to curb agency problems, not a cost created by those problems. So while internal controls have their own expense, they are used to mitigate agency costs rather than constitute them.