Please enable JavaScript.
Coggle requires JavaScript to display documents.
LO 4. SHAREHOLDER - DEBTHOLDER AGENCY PROBLEMS (role of debt contracts in…
LO 4. SHAREHOLDER - DEBTHOLDER AGENCY PROBLEMS
role of debt contracts in agency context
assume that the manager is either the sole owner if the firm
or has interest that are totally aligned with the interest of the owners
the principal is the debtholder
the agent is the manager acting on behalf of shareholders
firm value isthe value of debt plus the value of equity
the value of equity can be increased by
increasing the value of the firm
transferring wealth away from debtholders
Varieties of opportunistic behaviour
excessive of dividend payments
arises whent debt is lent to a firm on the assumption of a certain level of divident payout
reduces the asset base securing the debt
the debt becomes mispriced
reduces the value of the debt
asset subtitutions
based on the premise that lenders are risk averse
shareholders are able to diversify and have limited liability
debt become mispriced
Underinvestment
occurs when owners have incentives not to undertake positive NPV projects 'cause to do so would increase the funds available to the debtholders, but not the owners
Claim Dillutions
occurs when the firm issues debt of a higher priority than the debt already on issue
increase the funds available to increase the value of the firm and the value of ownership interest
but decreases the relative security and value of the existing debt
Debt Covenant
terms and conditions written into debt contract that restrict the activities of management or require management to take certain actions
categories of covenant contained in debt contracts
covenant that restrict the production-investment opportunities of the firm
covenant restraining dividend payouts and typically tying dividend payments to a function of profit
covenant restraining the financing policy of the firm
bonding covenants that require the firm to provide certain information to lenders