Equity contracts account for a small fraction of external funds raised by Canadian businesses because ________.
A) costly state verification makes the equity contract less desirable than the debt contract
B) of the reduced scope for moral hazard problems under equity contracts, as compared to debt contracts
C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt
D) there is no moral hazard problem when using a debt contract

Question

Quizplus · Accepted Answer

Costly state verification is a major deterrent for businesses to choose equity contracts over debt contracts. In equity contracts, investors become part owners of the firm and have a claim over its profits, but verifying the firm's true profitability is difficult and expensive for the state. This increases the risk for investors and reduces the attractiveness of equity contracts as a funding option for businesses.

Equity Contracts Account for a Small Fraction of External Funds