Issuing debt instead of new equity in a closely held ﬁrm more likely:
A)causes the owner-manager to work less hard and shirk their duties as they have less capital
At risk.
B)causes the owner-manager to consume more perquisites because the cost is passed to the
Debtholders.
C)causes both more shirking and perquisite consumption since the government provides a tax
Shield on debt.
D)causes agency costs to fall as owner-managers do not need to worry about other
Shareholders.
E)causes the owner-manager to reduce shirking and perquisite consumption as the excess
Cash ﬂow must be used to meet debt payments.

Question

Quizplus · Accepted Answer

Issuing debt instead of new equity in a closely held firm is more likely to cause the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments. This is because the company has a legal obligation to make regular interest and principal payments to the lenders. If the owner-manager does not meet these obligations, the company may face bankruptcy or financial distress, which can harm their reputation and financial position. Therefore, the owner-manager is motivated to work harder and avoid consuming excessive perquisites, which can hurt the company's ability to meet its debt obligations. This is known as the agency cost of debt, which refers to the costs incurred in monitoring and controlling the behavior of the owner-manager to protect the interests of the lenders.

Issuing Debt Instead of New Equity in a Closely Held