Moral hazard is NOT eliminated in debt financing because
A) borrowers have an incentive to assume greater risk than is in the interest of the lender.
B) firms with a great deal of debt often go bankrupt.
C) principal-agent problems are greater with debt financing than with equity financing.
D) the use of restrictive covenants tends to increase moral hazard.

Question

Quizplus · Accepted Answer

Moral hazard arises when one party takes on risks while another party bears the cost of those risks. In debt financing, the borrower has an incentive to take on greater risks than the lender would like, as the borrower only stands to gain from the upside while the lender bears the downside. Therefore, moral hazard is not eliminated in debt financing.

Moral Hazard Is NOT Eliminated in Debt Financing Because