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
Determine the name of some profit margin ratios Other profit margin ratios can also be computed: Gross profit/ turnover Profit after tax/ turnover Advertising co

Balance Sheets Peony Ltd. Aster Ltd. Assets: Cash $ 62,500 $ 25,000 Accounts receivable 187,500 200,000 Inventori

Explain the four fundamental rights of ownership A shareholder, by virtue of being an owner, is generally entitled to four fundamental rights of ownership: 1. Claim on a sha

Aligning Financial Reports: The primary purposes of financial systems are to provide information to interested parties.  Any reports produced through the financial management p

(i) No External Financing: - Walter' model presume that the firm's investment are financed exclusively by retained earnings and no external financing is used. If it was therefore t

Q. Explain about Routine Functions? Routine Functions: - The routine functions are Supervision of cash receipts and payments. Opening Bank Accounts as well as managing them Saf

Question 1: i) Performance budgeting is the best budgeting system. Discuss. ii) Why there is a need for implementing MTEF in the Mauritian Public Sector? Questi

Explain about the Working Capital Management Working Capital Management is concerned with the management of current assets. It's a significant and integral part of financial m

What role does depreciation play in calculating incremental cash flows? Depreciation expense is a tax deductible expense and hence influences cash flow by its effect on taxes.Dep

State the objectives of Corporate financial Corporate financial objectives could be to: 1. Provide the link between business and the other entities in environmentand 2.