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A type of agency problem that results in shareholders gaining by choosing not to finance new,...

Question:

A type of agency problem that results in shareholders gaining by choosing not to finance new, positive-NPV projects is:

a. asset substitution.

b. debt overhang.

c. excessive risk-taking.

d. distress costs.

Net Present Value (NPV):

Net present value abbreviated as NPV is one of the techniques of capital budgeting, where the value of future cash flows are determined. A project with positive NPV (where Net present value is greater than zero) is selected.

Answer and Explanation:

The correct option is B: Debt overhang.

Explanation: Debt overhang is a situation where an entity is not able to opt for new investment or borrowing because of its existing debt.

The investors or shareholders of the organization decide not to take a new positive NPV project and distribute dividends incurred from an existing project instead. This is so because even if the project is earning higher profits, it will be paid to the existing creditors of the organization.

So, this situation represents debt-overhang.


Learn more about this topic:

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What Is Financing? - Definition & Types

from Corporate Finance: Help & Review

Chapter 8 / Lesson 7
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