One of the indirect costs of bankruptcy is the incentive for managers to take large risks.When following this strategy:
A)the ﬁrm will rank all projects and take the project which results in the highest expected value
Of the ﬁrm.
B)bondholders expropriate value from shareholders by selecting high risk projects.
C)shareholders expropriate value from bondholders by selecting high risk projects.
D)the ﬁrm will always take the low risk project.
E)Both A and B.

Question

Quizplus · Accepted Answer

Shareholders may expropriate value from bondholders by selecting high-risk projects because if the project succeeds, shareholders gain significantly, while if it fails, bondholders bear most of the loss due to the fixed nature of their claims. This is known as the risk-shifting or asset substitution problem.

One of the Indirect Costs of Bankruptcy Is the Incentive