explain how conflicts of interest between bondholders and stockholders can lead to costs of financial distress.
Capital structure of any firm is crucial to all its stakeholders i.e shareholders and bondholders. When a company has debt in its capital structure in proportion greater than the equity, then there arises a situation of conflict of interests between the two. The shareholders are individuals or institutions that legally own shares of stock in the corporation, while the bondholders are the firm's creditors. The two parties have different relationships to the company, accompanied by different rights and financial returns. For example, stockholders have an incentive to take riskier projects than bondholders do , as bondholders are more interested in strategies that will increase the chances of getting their investment back. Shareholders also prefer that the company pay more out in dividends than bondholders would like. Shareholders have voting rights at general meetings, while bondholders do not. If there is no profit, the shareholder does not receive a dividend, while interest is paid to debenture-holders regardless of whether or not a profit has been made. Other conflicts of interest can stem from the fact that bonds often have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely but can also be sold at any point.e principals' interests.Because bondholders know this, they may create ex-ante contracts prohibiting the management from taking on very risky projects that might arise, or they may raise the interest rate demanded, increasing the cost of capital for the company. For example, loan covenants can be put in place to control the risk profile of a loan, requiring the borrower to fulfill certain conditions or forbidding the borrower from undertaking certain actions as a condition of the loan. This can negatively impact the shareholders. Conversely, shareholder preferences--as for example riskier strategies for growth--can adversely impact bondholders. Thus, the company needs to look into the interests of all its stakeholders to serve the best interests of all keeping in view its objectives
explain how conflicts of interest between bondholders and stockholders can lead to costs of financial distress.
20. Conflicts of interest between stockholders and bondholders are known as: 1. dealer costs. 2. trustee costs. 3. agency costs. 4. underwriting costs. 5. financial distress costs. 21. MM's proposition II states that the: 1. greater the proportion of equity, the higher the expected return on debt. 2. firm's capital structure is irrelevant to value determination. 3. expected return on assets decreases as expected return on debt decreases. 4. expected return on equity increases as financial leverage increases. 22. One...
Which one of these best describes the relationship between bondholders and stockholders at a time when it appears the firm may be facing increased financial distress? Multiple Choice A.) Stockholders have an incentive to underinvest in new projects to the detriment of bondholders. B.) Both parties tend to work together for the common good of the firm. C.) Both bondholders and stockholders will encourage the firm to take on new high risk projects. D.) Bondholders will tend to lower their...
a company can incur costs of financial distress without ever going bankrupt. explain how this can happen.
As a result of a recession, Yellowstone corporation is in financial distress. Which one of the following best characterizes the likely interaction between bondholders and shareholders of Yellowstone? a) Both bondholders and shareholders will encourage the firm to take on new high risk projects. b) Bondholders reduce their required rate of interest so the firm can obtain additional financing until its financial status improves. c) Bondholders tend to milk the property at the expense of stockholders. d) Shareholders have an incentive...
In financial distress, firms may make sub-optimal investment decisions. Explain the rationale behind this statement. What are the direct and indirect costs of bankruptcy? Give examples of firms with high and low bankruptcy costs and explain. “Stockholders need not be concerned with bankruptcy costs since they will be borne by bondholders.” Comment. (Assume that the firm declares bankruptcy when the value of assets is less than the value of obligations to bondholders. Thus, in bankruptcy, equity has zero value.) “Stock prices fall when...
Unsatisfactory Explain what is meant by “conflicts of interest and how they arise.
Ignore financial distress costs. When [(1 − TC) × (1 − TS) = (1 − TB)], then firms: a. should be all-equity financed. b. discover that both dividends and interest payments are non-deductible business expenses. c. tend to be indifferent between issuing debt or issuing equity. d. need to maintain a debt-equity ratio of .5. e. can reduce their taxes by increasing their dividend payouts.
19. How can variation between organisms be maintained or created? 20. Explain how migration can lead to evolution or prevent it from happening.
Please answer each question with at least 50 words.
1. Explain how asymmetric information in a product market can lead to market failure. 2. Give an example that illustrates the difference between private costs and social costs. 3. Explain how both an emission tax and tradable pollution permits system can reduce pollution.
1. Explain how asymmetric information in a product market can lead to market failure. 2. Give an example that illustrates the difference between private costs and social costs....
What are the five major forces that can lead to financial crises? Explain each of these forces in depth.