Debt holders versus shareholders, Financial Management

Debt holders versus Shareholders

A second agency problem arises because of potential conflict between stockholders and creditors. Creditors lend finances to the firm at rates which are based on:

  1. Riskiness of the firm's existing assets
  2. Expectations concerning the riskiness of future assets additions
  3. The firm's existing capital structure
  4. Expectations regarding future capital structure modifications.


These are the factors which determine the riskiness of the firm's cash flows and therefore the safety of its debt issue. Shareholders (acting via management) might make decisions that will cause the firm's risk to change. This will influence the value of debt. The firm might raise the level of debt to boost profits.  This will decrease the value of old debt since it raises the risk of the firm.

Creditors will defend themselves against the above troubles through:

(A) Insisting on uncertain covenants to be incorporated in the debt contract. Such covenants might limit:

•    The company’s benefit base
•    The company’s capability to get additional debts
•    The company’s capability to pay future dividend and management compensation.
•    The management capability to make future judgment (control associated covenants)

(B) When creditors observe that shareholders are trying to take benefit of them in unethical manners, they will either decline to deal further with the firm or else will need a much higher than normal rate of interest to recompense for the risks of such feasible exploitations.

It thus follows that shareholders wealth maximization need fair play with creditors. This is as shareholders wealth based on continued access to capital markets that depends on fair play by shareholders as far as creditor's interests are anxious.

Posted Date: 12/8/2012 6:58:45 AM | Location : United States







Related Discussions:- Debt holders versus shareholders, Assignment Help, Ask Question on Debt holders versus shareholders, Get Answer, Expert's Help, Debt holders versus shareholders Discussions

Write discussion on Debt holders versus shareholders
Your posts are moderated
Related Questions
critically appraise baumol max. theory as an alternative objective of the firm

Stock A has settled into a constant dividend growth pattern of 6 percent per year. The current dividend is $1.50, its current price is $15.90. You are an analyst and believe that

I am facing some problems in my assignment of Liquidity Mix. Can anybody suggest me the proper explanation for it?

Q. How are the HIBOR, HSI and HSI futures related? The HIBOR and HSI are contrariwise related. So futures on HIBOR and HSI are as well inversely related. Display

Ricardo Martinez has prepared the following financial statement projections as part of his business plan for starting the Martinez Products Corporation.  The venture is to manufact

Q. Explain about Deferred Payment? suppose a person take a loan of a specified amount at a given rate of the interest. he wants to repay this loan together with the interest in

What is Performance appraisal - cost of capital Performance appraisal further, cost of capital framework can be used to evaluate financial performance of top management. I

In US, savings and loan associations constitute the major originating group of the traditional loans. What types of properties can be mortgaged?

What is the Trade payable days (turnover) Year-end trade payables/Credit purchases (or cost of sales)x   365days This is the length of time taken to pay suppliers. The rat

Lease A lease is a contractual arrangement allowing one party the use of some exact assets for a specific times period in exchange for a payment it is same as a rental arrangem