Question

Using the stockholder-bondholder conflict, explain why stockholders get an excess return when they switch to higher risk, higher return projects. In what sense is the return they get excess?

Answer 1

Stockholders Are The Owners Of The Company, While Bondholders Are Considered As Creditors Of The Company.

Bond Holders Gets Interest From The Company Ata Regular Period Of Intervals Hence They Are Having Limited

Interest In The Profitability Of The Company. On The Other Hand Stockholders Are Intersted In The Profitability Of

The Company Because Their Wealth Would Increase In Terms Of Increase In The Market Price Of The Shares When

The Company In Which They Have Invested Ge,Nrates Profit.

There Is A Direct Relation Between Risk And Reward. Higher Risk Is Rewarded By A Higher Return. Stockholders

Are Having Long term Interest In The Company However Bondholders Are Having Short Term Interest In The

Company.Stockholders Wants The Company To Reinvest Its Profit In To The Business For The Growth And Expansion

Of The Company So As To Enable The Company To Generate More Profit And In Return Their Wealth Would Also

Increases Because They Are Taking Risk That They Will Not Get Anything From The Company At Regular Period Of

Intervals And They Will Not Get Priority To Receive Their Money In The Case Of Liquidation Of The Company Which

The Bondholders Gets

The Stockholders Would Get Excess Return As Compared To Bondholders In A Sense That Bondholders Would Not Get

Anything Over And Above Their Interest. On The Other Hand Stockholders Would Get Increase In The Market Price Of

Their Shares,Bonus And Dividend From The Company Because Of The Risk Undertaken By Them..