Mini Case Debt vs Equity Holders Companies obtain their funds from two sources: debt and equity. The providers of these funds are protected in different ways. Debt holders have specific contracts with the company, and if the company defaults, they have recourse ahead of shareholders. Shareholders are the bearers of residual risk and in return for the uncertainty this creates, equity finance is more expensive than debt finance – reflecting the risk premium and risk appetite of the shareholders. But, because the shareholders come last and it is not clear what they are entitled to, they operate in conditions of an incomplete contract. Question: If the shareholder’s position is not protected by a contract – unlike the provider of debt- how is it in fact made viable? Discuss
Mini Case Debt vs Equity Holders
Companies obtain their funds from two sources: debt and equity. The providers of these funds are protected in different ways. Debt holders have specific contracts with the company, and if the company defaults, they have recourse ahead of shareholders.
Shareholders are the bearers of residual risk and in return for the uncertainty this creates, equity finance is more expensive than debt finance – reflecting the risk premium and risk appetite of the shareholders. But, because the shareholders come last and it is not clear what they are entitled to, they operate in conditions of an incomplete contract.
Question:
If the shareholder’s position is not protected by a contract – unlike the provider of debt- how is it in fact made viable? Discuss
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
