Agency costs + asymm information & payout policy

Question 1

what are agency costs borne by equity holders

Answer 1

agency costs of equity - when shareholders need to monitor management

Question 2

what are the agency costs borne by debt holders

Answer 2

agency cost of debt - when the debtholders nee dto monitor shareholders from exploiting limited liability

Question 3

implications of agency costs?

Answer 3

limited liability, reduce firm value

Question 4

what is asset substitution?

Answer 4

moving from safe assets to risky assets to fetch higher returns for shareholders is known as asset substitution . There is a transfer of value from bond holders to equity holders

Question 5

which projects will equity holders take?

Answer 5

those which maximise equity value, may have negative returns (NPV) or highly risky

Question 6

what does agency cost of debt do?

Answer 6

reduces firm value, increases the cost of debt

Question 7

what is underinvestment?

Answer 7

When SH say no to a positive NPV project which adds value to DH and firm but diminishes value from SH

Question 8

underinvestment appraisal rule?

Answer 8

deltaE>deltaI

Question 9

underinvestment is high for which firms?

Answer 9

firms that have a high proportion of debt in their balance sheet and growth options that require large investments

Question 10

solutions to underivestment probelm?

Answer 10

lower debt, renegotiate debt

Question 11

Agency costs of equity higher when?

Answer 11

smaller the managers holdings, higher the agency cost of equity

Question 12

what is the agency cost of FCF?

Answer 12

When managers grow the firm more than optimal if their compensation is linked to firm size/value. managers may invest in -ve NPV projects to gain a bigger firm

Question 13

What is the solution to agency cost of FCF?

Answer 13

debt as a discplining device

Question 14

how is my optimal D/e supposed to be when i include agency costs of FCF and Debt

Answer 14

leverage inc with FCF and reduces with Debt

Question 15

can static trade off theory with agency costs explain announcements effects

Answer 15

NO

Question 16

Under assymetrical information, managers should issue equity when?

Answer 16

when the stock is overvalued, P>A(actual P) so they get more money for their stock [old shareholders gain]

Question 17

What do Myers and Majluf say about issuance of equity when overvalued?

Answer 17

because you only issue equity when overvalued, it is negative signal

Question 18

why does asymmetrical information cause a reduction in firm value?

Answer 18

if a firm wants to invest in a project but needs cash, it cannot issue equity (signal of overvaluation) thus needs to look at other methods.

Question 19

why issue debt over equity?

Answer 19

because debt says less about firm value compared to equity

Question 20

What did Myers and Majluf come up with

Answer 20

Pecking order theory according to information sensitivity

Question 21

In static trade off theory 1 we couldn’t explain why highly profitable firms don’t issue debt, is it solved in POT?

Answer 21

Yes, because profitable firms have internal funds

Question 22

What is the Marketing Timing Theory and who came up with it?

Answer 22

Baker and Wurgler 2000)
firms more likely to issue equity when MV is high now relative to book value and past market value
Current capital structure related to past market value

Question 23

What are the most important factors of leverage?

Answer 23

tangibility of assets + uncertainity of operating income

Question 24

how do firms disburse cash to Sh?

Answer 24

sharebuy backs and cash dividends

Question 25

why do we study payout policy?

Answer 25

to see if payout policy affects firm value

Question 26

does a stock split add value to the firm?

Answer 26

no, it does not add value, only holdings get diluted

Question 27

what do you shares trade on during the ex- dividend date?

Answer 27

cum -dividend

Question 28

3 methods of stock repurchases?

Answer 28

OPM, tender offer, targeted repurchase

Question 29

MM(1961)

Answer 29

Value of a firm with fixed investment policy is unaffected by payout policy

Question 30

What is the total value of a share under MM1961

Answer 30

Total value = ex-dividend price + dividend per share

Question 31

What did Elton and Gruber Find?

Answer 31

higher the implied tax bracket, lower the dividend yield