Asked by William Russell on Jul 14, 2024
Verified
The problem of 'underinvestment' occurs when managers are reluctant to undertake projects with positive net present value because:
A) shareholders prefer less risk than do lenders and managers.
B) the increased funds obtained from the projects will rank higher in priority of payments to creditors over shareholders in the event of the entity being liquidated.
C) the projects would result in a reduction of managers' incentives.
D) managers prefer to maintain a high level of funds within the entity.
Underinvestment
The situation where a company or individual invests less than is optimal, potentially leading to lower returns or growth than possible.
Net Present Value
The difference between the present value of cash inflows and outflows over a period of time, used in capital budgeting to assess the profitability of an investment.
Liquidated
The process of converting assets into cash or paying off a debt by selling assets, often related to the winding down or closing of a business.
- Acquire knowledge on the basics of agency theory and the relationship between the owner and the manager, taking into account risk aversion and different agency concerns.
Verified Answer
NL
Natalia LarinJul 16, 2024
Final Answer :
B
Explanation :
The increased funds obtained from the projects will rank higher in priority of payments to creditors over shareholders in the event of the entity being liquidated. This creates a conflict of interest between managers and shareholders, as managers may prioritize their own interests over those of the shareholders by avoiding projects that would benefit shareholders but potentially harm managers in the event of liquidation.
Learning Objectives
- Acquire knowledge on the basics of agency theory and the relationship between the owner and the manager, taking into account risk aversion and different agency concerns.