ABSTRACT. The principal objectives in this paper are to
assess and to build upon the recently published research of
Ang et al. (2000) making a pioneering attempt to estimate
equity agency costs in a large cross-sectional sample of
smaller, non-publicly traded companies in the United States.
The present research employs panel data for 871 manufac-
turing SMEs legally organised as proprietary companies,
taken from the Australian federal government’s Business
Longitudinal Survey conducted over four financial years from
1994–1995 to 1997–1998. The two proxies for equity agency
costs that are trialed – operating expense ratio and asset
turnover ratio – both appear lower in more complex agency
relationships. It is also found that greater enterprise growth
is significantly more evident amongst SMEs with more
complex agency relationships. Thus, it is possible that
observed differences in values for the two equity agency cost
proxies are not the direct consequence of differences in man-
agement and ownership structures; but, rather, of differences
in the experience of enterprise growth, possibly enabled to
some degree by the management and ownership structures
adopted. This raises the question of whether, in fact, operating
expense ratio and asset turnover ratio can be reliably used as
proxies for equity-related agency costs in SME research.
A theoretical perspective that has contributed
significantly to modern financial theory is that
of agency theory, which considers a business
enterprise from the viewpoint of the various
stakeholders it might have, and explores how
financial (that is, pecuniary or monetary)
interests are furthered and protected in their
dealings with each other. The stakeholder rela-
tionships that receive most attention in the small
and medium-sized enterprise (SME) literature are
• Managers and owners.
• Owner-managers and other owners.
• Insiders (primarily owners and managers) and
outsiders (mainly creditors and lenders).
The central dilemma in agency theory is that day-
to-day control of an SME’s activities and finan-
cial fortunes very often rests in the hands of only
some stakeholders who are usually managers or
owner-managers. Yet all stakeholders have a legit-
imate expectation that their interests will be well
served. By analogy with legal notions of agent and
principal, those who exercise control are seen as
being agents for the other stakeholders who are
considered to be principals.
The most significant problems that may arise
from agency relationships in SMEs are:
• Information asymmetry.
• Moral hazard.
• Adverse selection.
One rational response to the inherent risk posed
by self-interest on the part of agents, and other
behaviours detrimental to principals in agency
relationships, is for each stakeholder to increase
the reward expected in return for participation in
the business. Other possible responses are of two
An important point about these responses to
agency-related risk is that they are not costless.
The out-of-pocket costs of maintaining an agency
relationship may therefore include higher costs of
Richard G. P. McMahon
Small Business Economics 22: 121–140, 2004.
2004 Kluwer Academic Publishers. Printed in the Netherlands.
Final version accepted on 3 March 2002
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