With debt financing
A)moral hazard problems are eliminated.
B)moral hazard problems are reduced but not eliminated.
C)adverse selection problems are eliminated.
D)firms reduce the risk that they will become bankrupt during a recession.

Question

Quizplus · Accepted Answer

Debt financing reduces moral hazard problems as borrowers have a contractual obligation to repay the debt. However, moral hazard cannot be completely eliminated as borrowers may still engage in risky behavior and default on their debt. Adverse selection problems are not eliminated with debt financing as lenders may still face the issue of not being able to distinguish between high-risk and low-risk borrowers. Debt financing may increase the risk of bankruptcy during a recession as interest payments on the debt must still be made, regardless of the firm's financial standing.

With Debt Financing