What is Managerial Agency Costs

The O.M. Scott case study published in 1989 has come to be a classic in modern corporate finance. High leverage traditionally appears as a strong incentive to refrain from sub-optimal investment behavior by self-interested managers. Thus reducing managerial agency cost has been considered as an essential driver of enhanced value in much of financial modeling. The present chapter attempts a somewhat different, albeit complementary, mainly resource based interpretation of the very rich empirical material contained in Baker and Wruck's description of the Scott-LBO. In fact, a close reading of the case suggests that the observed significant increase in operating performance post-LBO is to a great extent the consequence of yet unexplored cognitive changes induced by the private equity firm leading the operation. One may hypothesize that concepts of cognitive value and cognitive cost are relevant to entrepreneurial finance, especially in the case of funding highly innovative young ventures.