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)stockholders expropriate value from bondholders by selecting high risk projects.
C)stockholders expropriate value from stockholders by selecting high risk projects.
D)the firm will always take the low risk project.
E)Both A and B.

Question

Quizplus · Accepted Answer

When managers have incentives to take large risks, they may prioritize high-risk projects that offer the potential for large gains, even if those gains come at the expense of bondholders. In this scenario, stockholders are essentially expropriating value from bondholders. Option A is incorrect because selecting the project with the highest expected value may still involve a certain level of risk-taking. Option C is incorrect because it suggests that stockholders are taking value from themselves, which doesn't make sense. Option D is incorrect because it suggests that the firm will always choose the low-risk project, which may not be the case if managers are incentivized to take risks.

One of the Indirect Costs of Bankruptcy Is the Incentive