Agency Costs and the Underlying Causes of Mispricing

Abstract

We investigate the link between agency costs and equity mispricing. We find that mispricing is positively related with agency costs caused by divergent objectives between agents and owners in the presence of information asymmetry where managers discriminately have better/more information than owners. Our investigation extends previous studies arguing that information asymmetry is simply a key determinant of mispricing. We show that, for a given level of information asymmetry, conflicts of interest can substantially exacerbate mispricing. Furthermore, we find that stock option grants, originally intended to resolve conflicts of interest, actually exaggerate this problem, and thus lead to greater mispricing.

Keywords: Agency costs, equity mispricing, stock options

JEL Classification: G12, G14, D82, J33