Section A

Founders of a successful family-owned manufacturing business are planning an Initial Public Offering (IPO) to raise capital for expansion. Following the IPO, the founders will retain 20% of the shares but will step down from the board, hiring professional managers to run the company.

According to Agency Theory, what is the most likely consequence of this transition?

Agency theory deals with the relationship between principals (shareholders) and agents (directors/managers). In a family-owned business where owners are managers, agency costs are minimal. Post-IPO, the separation of ownership and control creates a principal-agent problem. Managers may pursue personal goals (e.g., empire building, excessive perks) rather than maximizing shareholder wealth, leading to agency costs (monitoring costs, bonding costs, and residual loss).