Issuing Debt Instead of New Equity in a Closely Held

question 37

Multiple Choice

Issuing debt instead of new equity in a closely held firm more likely:

• A) causes the owner-manager to work less hard and shirk their duties as they have less capital at risk.
• B) causes the owner-manager to consume more perquisites because the cost is passed to the debtholders.
• C) causes both more shirking and perquisite consumption since the government provides a tax shield on debt.
• D) causes agency costs to fall as owner-managers do not need to worry about other shareholders.
• E) causes the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments.

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Definitions:

Agent

A party primarily engaged to act on behalf of and for the benefit of another party or parties (the principal(s)) which therefore does not control the investee when it exercises its decision-making authority.

Variable Returns

Returns from an investment that fluctuate over time due to market conditions or other factors.

Economies of Scale

Cost advantages that entities experience as their operational size or volume increases, leading to reduced costs per unit of output.

Remuneration

The compensation a person receives in return for performing work or services, including wages, salaries, and benefits.