The "threat hypothesis"
A) reduces management's tendency to spend freely.
B) encourages management to use debt to further their own interests.
C) increases the agency problem.
D) increases agency monitoring costs.

Question

Quizplus · Accepted Answer

The threat hypothesis suggests that managers are more likely to act conservatively and avoid excessive spending when faced with the potential threat of a takeover or activist shareholder intervention. This reduces their tendency to spend freely.

Answer: C 
 The threat hypothesis can increase the agency problem by giving managers an incentive to focus on short-term performance rather than long-term value creation. This could lead to decisions in the interest of the managers rather than the shareholders.

Answer: D 
 The threat hypothesis can also increase agency monitoring costs as shareholders may need to invest time and resources in monitoring the actions of the management team and ensuring that they are acting in their best interests.

The "Threat Hypothesis