Positive accounting research guided the search for explanations for firms' accounting choice and other firm variables. Positive accounting theory is associated with agency theory with firms being thought of as a nexus of contracts put in place to ensure that all parties, acting in their own self-interest are motivated to maximise firm value. Watts, R. L., and J. L. Zimmerman 1990.Positive Accounting Theory: A Ten Year Perspective.The Accounting Review, 65(1): 31-156.

1. Explain how the debt/equity hypothesis relates to the agency cost of debt.

2.What do the principals (lenders) do to stop the agent (management) acting in their own self-interest to reduce agency costs?

thanks