L4: Debt and Incentives

Question 1

Agency costs

Answer 1

Question 2

Example where use of leverage creates a conflict btw S/H and D/H

Answer 2

Question 3

“Games” played by shareholders at the expense of creditor
Suppose a levered firm is choosing between two projects with equal NPV, one of which is riskier than the other. Are equity- and debt-holders indifferent between the two?

Answer 3

Question 4

“Games” played by shareholders at the expense of creditor
Suppose a levered firm is choosing between two projects with equal NPV, one of which is riskier than the other. Are equity- and debt-holders indifferent between the two?
- Consequences

Answer 4

Question 5

Where do conflicts of interest btw D/H and S/H arise?

Answer 5

Question 6

Who pays for risk-shifting behaviour?

Answer 6

Question 7

Do we see the risk-shifting behaviour in practice?

Answer 7

Question 8

Why can’t we avoid costs of financial distress by renegotiating with creditors?

Answer 8

Question 9

Do we observe the debt-overhand problem in reality?

Answer 9

Question 10

What are the implications from the agency conflicts?

Answer 10

Question 11

Mitigating Asset Substitution

Answer 11

Question 12

Leverage and Managers - Shareholder conflicts

Answer 12

Question 13

Debt and Incentives to maximize NPV

Answer 13

Question 14

JensenandMeckling (1976)

Answer 14

Question 15

JensenandMeckling (1976): Assumptions

Answer 15

Question 16

“Effort” Is a Metaphor

Answer 16

Question 17

Private benefits examples

Answer 17

Question 18

MM and moral hazard

Answer 18

Question 19

Investor break-even conditions

Answer 19

Question 20

Optimality of debt

Answer 20

Question 21

How to figure out if its best to finance the project with debt or equity

Answer 21

Question 22

How to handel managerial finance problem?

Answer 22

Question 23

Agency costs

Answer 23

Question 24

Limitations of risk shifting potential

Answer 24

Question 25

How can this risk shifting behaviour be mitigated?

Answer 25

Question 26

Advantage of debt

Answer 26

Question 27

Effort problem by Jensen&Meckling

Answer 27

Question 28

Further applications Jensen & Meckling

Answer 28

Model can also be applied to:

• any internal E/H, even if they are only part of the firm (provides effort and at the same time ownes a fraction of the firm)

Question 29

When is the Jensen & Meckling model applied?

Answer 29

Question 30

Leveraged recapitalization

Answer 30

Issue debt to repurchase shares

Question 31

FCF and incentive benefits of debt

Answer 31

Question 32

For whom is the agency cost of debt more important?

Answer 32

Question 33

Taking into account the additional benefit of leverage: “Augmented” trade-off model

Answer 33

Question 34

Practical implications

Answer 34