That is agency costs arise whenever economic agents

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Unformatted text preview: . That is, agency costs arise whenever economic agents enter into contracts in a world of incomplete information and thus costly information collection. The more difficult and costly it is to collect information, the more likely it is that contracts will be broken. In this case the saver (the so-called principal) could be harmed by the actions taken by the borrowing firm (the so-called agent). One solution to this problem is for a large number of small savers to place their funds with a single FI. This FI groups these funds together and invests in the direct or primary financial claims issued by firms. This agglomeration of funds resolves a number of problems. First, the large FI now has a much greater incentive to collect information and monitor actions of the firm because it has far more at stake than does any small individual household. This alleviates the free-rider problem that exists when small household savers leave it to each other to collect information and monitor the actions of firms...
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