One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When following this strategy, the firm will:
A) rank all projects and take the project which results in the highest expected value of the firm.
B) rank all projects and take the project which results in the highest expected value of the firm's bonds.
C) rank all projects and take the project which results in the highest expected value of the firm's stock.
D) always take the low risk project.

Question

Quizplus · Accepted Answer

When a firm is close to bankruptcy, managers may have an incentive to undertake projects that favor stockholders over bondholders, often by taking on high-risk projects. If the project succeeds, the stockholders gain significantly, while if it fails, the losses are largely borne by the bondholders. This strategy aims to maximize the expected value of the firm's stock, not the overall value of the firm or its bonds.

One of the Indirect Costs of Bankruptcy Is the Incentive