ADMN 4300H Lecture Notes - Lecture 4: Net Present Value, Agency Cost, Cash Flow
30 Mar 2020
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Description of costs of financial distress: direct costs. Legal and administrative costs (tend to be a small percentage of firm value) Impaired ability to conduct business (e. g. , lost sales: agency costs conflict of interest between shareholders and bondholders. Selfish strategy 1: incentive to take large risks. Balance sheet for a company in distress: what happens if the firm is liquidated today, the bondholders get , the shareholders get nothing. Selfish shareholders accept the gamble because the value of the shares is higher. Shareholders reject the project since the benefits are shared with the bondholders even though shareholders have contributed the full for the investment. Suppose our firm paid out a dividend to the shareholders. This leaves the firm insolvent, with nothing for the bondholders, but plenty for the former shareholders. Can costs of debt be reduced: protective covenants, negative covenants, positive covenants, debt consolidation: If we minimize the number of parties, contracting costs fall.
