Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.

Question

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When the risk of financial distress is high, equity-debt holder conflicts may occur because in case of bankruptcy, the debt holders have a priority claim on the assets of the company while equity holders may lose their entire investment. This can create incentives for equity holders to take actions that benefit their interests but could jeopardize the financial health of the company and make it more likely to default on its debt. Therefore, in situations of high financial distress risk, the conflicting interests of equity and debt holders can become more acute.

Equity-Debt Holder Conflicts Are More Likely to Arise If the Risk