For firms with free cash flows,

Question

Quizplus · Accepted Answer

Debt provides a contractual obligation for the firm to make regular interest and principal payments, which can help bond managers to release free cash flows to investors. In contrast, equity dividends are not contractual and can be changed or skipped by the firm, making it less effective in credibly bonding managers to release free cash flows. Preferred stock dividends are also not contractual, and the firm has the ability to suspend or defer payments if needed, making it less effective than bonds.

For Firms with Free Cash Flows