A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is referred to as:

Question

Quizplus · Accepted Answer

This situation is referred to as the overinvestment problem or risk-shifting problem, where equity holders prefer to undertake high-risk projects in the hope of high returns rather than making payments to debt holders, as the firm's equity value is already diminished.

A Situation That Arises When a Firm's Equity Is Close