An examination of the relationship between agency costs and prices of stocks of companies quoted at the Nairobi Stock Exchange

Abstract

The current study evaluated the relationship between agency costs and the prices of stock public companies quoted at Nairobi Stock Exchange. The assumption in agency problem management is that managers will act in the best interest of the shareholders if some earnings are sacrificed by the shareholders to align the management behavior. The agency costs considered in this study include; emoluments paid to external directors, dividends paid to internal shareholders, and the audit costs. The data used in this paper was extracted from annual financial reports of companies listed at the Nairobi stock exchange and from Authorized Data Vendors by the Nairobi Stock Exchange Council. The data was collected through a desk research using data collection sheets. Descriptive statistics were used to present data and quantitative analysis was conducted to give meaning to the results. While there was some evidence of increased spending in agency costs by the studied companies over the period of consideration, there was no clear cut evidence that such increase in agency costs resulted in proportionate increase in stock prices over the same period. However there was evidence that all companies studied incur some form of agency costs and that the increase in the stock prices may have been influenced by that spending. It also became clear that, there is a strong positive correlation between the agency costs incurred by public companies and the prices of their stocks. However, more random factors other than the agency costs spending are seen to have influence the stock prices. Implications for the incurrence of agency costs are that, given the strong correlation that exists between the agency costs and the stock prices, it therefore becomes imperative for any public company to set aside some of its earnings in order to align management behavior towards the shareholders interest. Its also holds true that failure to spend its earnings on agency costs, any public company is likely to suffer residual loss , associated with managers pursuing interest other than those of the shareholders. The current study challenges the existing practices in public companies on incurring agency costs without considering the costs/benefit analysis. Therefore corporate business should attempt to come up with a scientific model that would help guide the shareholders on the extent to which agency costs should be incurred in order to influence stock prices of public companies.