Question

Agency costs arising from the conflicts of interest between shareholders and bondholders do not impose any real costs on the firm. Do you agree with this statement? Explain how shareholders can take wealth from bondholders through their investment, financing and dividend decisions. How can bondholders protect themselves? An article in an Asian business magazine argued that equity was cheaper than debt, because dividend yields are much lower than interest rates on debt. Do you agree with this statement? Please explain why you agree or disagree with this statement.

Answer 1

I do not agree with this statement because agency costs arising out of the conflict between the shareholders and managers are impacting the real cost of the company because it is leading to loss of profits and loss of opportunities for the company and it can also lead to investment into bad products.

Investors can take the income away from bondholders through their investment and financing decisions by investing into highly risky securities in order to make a very high rate of return so it can lead to risk related to payment of the bond holders and it can also increase the risk of default if the company is getting exposed into highly risky securities.

I disagree with this statement because debt capital have interest tax shield whereas dividend are taxed double and hence cost of equity will always be having a higher cost than the cost of debt, so I do not agree with this statement as debtholders are having an additional advantage in regard to tax deduction.