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.

Question

Quizplus · Accepted Answer

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.

The Problem of 'Underinvestment' Occurs When Managers Are Reluctant to Undertake