Issuing debt provides incentives for managers to run the firm efficiently because
A)debt increases the funds available to managers to run the firm.
B)shareholders prefer to decline new projects to save cash, even if their NPVs are positive.
C)ownership may remain more concentrated, improving monitoring of management.
D)managers may take actions that benefit shareholders but harm creditors and lower the value of the firm.

Question

Quizplus · Accepted Answer

Issuing debt increases the level of financial responsibility on the part of the firm's management to service the debt, which incentivizes them to run the firm efficiently to ensure that the required payments are made on time. Ownership may remain more concentrated if the firm issues debt instead of new equity, which can improve monitoring of management and further incentivize them to act in the best interest of shareholders. However, debt holders do not benefit from increases in the value of the firm as much as shareholders do, which can create conflicts between managers and creditors, and managers may take actions that benefit shareholders but harm creditors to elevate the value of the firm. Thus, while issuing debt provides incentives for managers to run the firm efficiently, it also increases potential conflicts between shareholders and creditors.

Issuing Debt Provides Incentives for Managers to Run the Firm