Agency costs + asymm information & payout policy Flashcards
what are agency costs borne by equity holders
agency costs of equity - when shareholders need to monitor management
what are the agency costs borne by debt holders
agency cost of debt - when the debtholders nee dto monitor shareholders from exploiting limited liability
implications of agency costs?
limited liability, reduce firm value
what is asset substitution?
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
which projects will equity holders take?
those which maximise equity value, may have negative returns (NPV) or highly risky
what does agency cost of debt do?
reduces firm value, increases the cost of debt
what is underinvestment?
When SH say no to a positive NPV project which adds value to DH and firm but diminishes value from SH
underinvestment appraisal rule?
deltaE>deltaI
underinvestment is high for which firms?
firms that have a high proportion of debt in their balance sheet and growth options that require large investments
solutions to underivestment probelm?
lower debt, renegotiate debt
Agency costs of equity higher when?
smaller the managers holdings, higher the agency cost of equity
what is the agency cost of FCF?
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
What is the solution to agency cost of FCF?
debt as a discplining device
how is my optimal D/e supposed to be when i include agency costs of FCF and Debt
leverage inc with FCF and reduces with Debt
can static trade off theory with agency costs explain announcements effects
NO
Under assymetrical information, managers should issue equity when?
when the stock is overvalued, P>A(actual P) so they get more money for their stock [old shareholders gain]
What do Myers and Majluf say about issuance of equity when overvalued?
because you only issue equity when overvalued, it is negative signal
why does asymmetrical information cause a reduction in firm value?
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.
why issue debt over equity?
because debt says less about firm value compared to equity
What did Myers and Majluf come up with
Pecking order theory according to information sensitivity
In static trade off theory 1 we couldn’t explain why highly profitable firms don’t issue debt, is it solved in POT?
Yes, because profitable firms have internal funds
What is the Marketing Timing Theory and who came up with it?
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
What are the most important factors of leverage?
tangibility of assets + uncertainity of operating income
how do firms disburse cash to Sh?
sharebuy backs and cash dividends
