Question

In: Economics

Explain how the following actions by shareholders would transfer wealth from debtholders to them (a) An...

Explain how the following actions by shareholders would transfer wealth from debtholders to them

(a) An increase in dividends

(b) Investment in riskier than expected projects

(c) Borrow more

Question 7: Discuss possible remedies for the agency problem between shareholders and managers.

Solutions

Expert Solution

.a)An increase in dividends:-

Shareholders may wish most of the firm's cash paid out to them as dividends. So if the dividends increase shareholders will get the most of the dividends.

b) Investment in riskier than expected projects :-

Investment is always a risky task because shareholders will never assume what would they get in return. Expected projects have fix returns, so the shareholders will get a sure amount from debt holders.

c) Borrow more :-

Commanly, borrow more debt is a worse thing for companies and shareholders because it holds back a company's efficiency to create a cash surplus. Moreover, increased debt levels may negatively affect common stockholders, who are last in line for claiming payback from a company that becomes collapse.

2. Possible remedies for the agency problem between shareholders and mangers :-

The agency problem is a dispute of interest inherent in any relationship where one party is anticipated to act in another's best interests. Following are the possible remedies;
a) Full transparency between the shareholders and mangers,
b) placing restrictions on the shareholders' capabilities,
c) use principal agent model.


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