A firm nearing bankruptcy has an incentive to issue more high risk debt.

Question

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A firm nearing bankruptcy may experience difficulty obtaining financing through traditional means, such as issuing equity or low-risk debt. As a result, they may turn to issuing more high-risk debt as a means of raising capital. The incentive to do so is that this type of debt typically offers a higher return to investors, but also carries a higher risk of default or non-payment. This can be a risky strategy for the firm, as it may further increase their financial instability, but it may be a necessary step to avoid bankruptcy.

A Firm Nearing Bankruptcy Has an Incentive to Issue More