One of the indirect costs to bankruptcy is the incentive toward under investment. Following this strategy may result in:
I. the firm always choosing projects with the positive NPVs
II. stockholders turning down low risk low return but positive NPV projects
III. stockholders would declare and receive high cash dividends

Question

Quizplus · Accepted Answer

Underinvestment occurs when stockholders reject low-risk, low-return projects with positive NPVs (II) because they prefer to take on riskier projects that might benefit them more if successful. Additionally, stockholders might prefer to receive high cash dividends (III) rather than reinvest in the firm, especially if they anticipate bankruptcy.

One of the Indirect Costs to Bankruptcy Is the Incentive