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
State about the Manufacturing overseas or exporting Dyson (appliances manufacturer) relocated UK production to Malaysia in 2002 though still retained its head office within the

Q. Illustrate Methods to Manage cash resources? There are several methods which may be of use in managing resources. The particular tool selected will depend on its reliability

Meaning merits nd demerits of modern approch of financial management

Wing Yin Tsui, CEO of Lian Huang & Wong Bin Dean Hwang Manufacturing Limited is considering a four year project. The project requires an initial investment of $10,000,000 to buy ne

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.

Explain the significance of the term additional funds needed. While the pro forma balance sheet is completed, total assets and total liabilities and equity will hardly match.



a) Describe five factors that should be taken into account by a businessman in making the choice between financing by short-term and long-term sources.

Various Types of Strategies Different types of hedge fund strategies are discussed as follows: Relative Value of Strategies: Relative value strategies are also known as no