To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because ________.
A) debt increases the funds available to managers to run the firm
B) ownership of managers may remain more concentrated
C) managers may take actions that benefit shareholders but harm creditors and lower the value of the firm
D) shareholders prefer to decline new projects to save cash, even if their NPVs are positive

Question

Quizplus · Accepted Answer

Issuing debt instead of equity can keep ownership more concentrated, which aligns management incentives with shareholders. With equity, shareholders own a portion of the company, but with debt, creditors have a lien on the assets of the company until the debt is repaid. Therefore, managers have a stronger incentive to maximize the value of the firm to ensure that the company can generate enough cash flow to pay back the debt. If managers take actions that harm the value of the firm, creditors may take control of the assets, and the value of the equity will decrease, causing harm to the shareholders.

To Reduce Agency Costs, Issuing Debt Instead of Equity Provides