Equity contracts account for a small fraction of external funds raised by American businesses because
A) costly state verification makes the equity contract less desirable than the debt contract.
B) there is greater 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) all of the above.
E) both A and B of the above.

Question

Quizplus · Accepted Answer

Costly state verification and moral hazard problems are two important reasons why equity contracts account for a small fraction of external funds raised by American businesses. This is because these problems are more severe under equity contracts than under debt contracts. Additionally, equity contracts do not permit borrowing firms to raise additional funds by issuing debt, which limits their flexibility in raising financing. Therefore, both options A and B are correct, resulting in the answer being E, "both A and B of the above."

Equity Contracts Account for a Small Fraction of External Funds