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 occurs when one party takes more risks knowing that the consequences of those risks will be borne by another party. In debt financing, borrowers may have an incentive to assume more risk than is beneficial to the lender because the lender bears the majority of the risk if the borrower defaults. Therefore, moral hazard is not eliminated in debt financing.

Moral Hazard Is Not Eliminated in Debt Financing Because