Actions of shareholders in agency conflict, Finance Basics

Actions of Shareholders in Agency Conflict

a) Disposal of assets required like collateral for the debt in this.

In this case the bondholder is exposed to more risk because he may not recover the loan extended in case of liquidation of the firm.

b) Assets or investment substitution

However, the bond holders and shareholders will agree on a specific low risk project.  Conversely, this project may be substituted along with a high risk project whose such cash flows have high standard deviation. This exposes the bondholders since should the project collapse, so they may not recover money advanced' the entire amount.

c) Payment of High Dividends

Dividends could be paid from recent net profit and the existing retained earnings. Retained earnings are an internal basis of finance.  The payment of high dividends will lead to low level of investment and capital so reduction in the market value of the bonds and the shares.

A firm may borrow debt capital to finance the payment too of dividends from that no returns are expected. Hence this will reduce the value of the bond and firm.

d) Under investment

This is whereas the firm fails to within a particular project or fails to invest money or capital in the whole project whether there is expectation such most of the returns from the project will advantageous the bondholders. This will guide to reduction in the value of the firm and consequently the value of the bonds.

e) Borrowing more debt capital

A firm may borrow more debt requiring the same asset as collateral for the new debt. The value of old bond or debt will be reduced whether the new debt gets a main concern on the collateral in case the firm is liquidated. These representation the first bondholders or lenders to more risk.

 

Posted Date: 1/29/2013 1:45:58 AM | Location : United States







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