FNCE30002 Lecture Notes - Lecture 2: Institute Of Noetic Sciences, Contingent Liability, Lease
Document Summary
K e y c h a r a c t e r i s t i c s o f d e b t: usually no voting rights, from investor"s view debt capital is the least risky type. In the case of bankruptcy, debtholders stand before shareholders. Cost of debt is lower than cost of equity due to lower risk: firm may "default" on its debt repayments. Try to protect wealth transfers to shareholders through covenants. Positive covenants: limit access to further debt prevents wealth transfer from debtholders to shareholders, restrict holding of certain investments, restrict dividends paid. Monitoring and contractual debt restrictions imposed by banks: constrain mangers from actions that reduce firm value, reduces likelihood of managers wasting money. Bank"s concern with maximising value of debt: not consistent with maximising shareholder value. Prevents managers from investing in +ve npv projects: decreases financial flexibility. Gives monopoly power to the bank in further borrowing negotiations with the firm.
