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
What is working capital? Working capital comprise of the current assets of the firm.

When the underlying stock becomes worthless, the percentage price declines the investors experience is given by, Percentage of Downside Risk=



Capital Asset Pricing Model (CAPM)   Capital Asset Pricing Model (CAPM) is a model which utilizes the measure of systematic risk, 'B' to price assets. The expected rate of r

Question 1 Write short notes on following- Explain any five important functions of accounting What is Book-Keeping? Explain features of book-keeping Question 2 Ex

This is usually the third- or fourth-highest rating that a rating agency allocates to a security or insurance carrier. It is frequently the lowest investment-grade rating, but it i

Introduction to Financial Management Companies don't work in a vacuum, isolated from everything else. It transacts andinteracts with the other entities present in economic envi

how can an operating cycle be applied to a poultry business

Margin Trading: Suppose an investor wants to buy 100 Reliance Energy shares, whose market price is Rs.500. This transaction requires Rs.50,000 but the investor has only Rs.30,0