This paper examines the effects of the agency costs on firm value in 156 Chinese publicly listed companies with individual ultimate owners between 2002 and 2007. The ultimate owners’ agency costs, as measured by the divergence between control rights and cash flow rights, are shown to negatively and significantly affect firm value, as measured by the market-to-book ratio of assets (an approximation of Tobin’s Q). As the agency costs grow, the stock returns decrease around the connected party transaction announcements, and firms are more likely to engage in value-destroying connected party transactions. These effects are particularly strong for some types of connected party transactions, notably loan guarantees and direct fund transfers. Further, as the agency costs grow, the firms violate laws more frequently and the nature of legal violations becomes more severe. Evidence from an exogenous policy shock, the non-tradable share reform confirms that higher agency costs cause more unfavorable stock market reactions to connected party transaction announcements.