The under-investment problem refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because:
A)future investments are contingent on debt financing.
B)projects are contingent on equity financing.
C)gains are evenly shared between all stakeholders.
D)most of the gains from the investment accrue to debt holders.
E)these investments will decrease share prices.

Question

Quizplus · Accepted Answer

In highly levered firms, most of the gains from positive-NPV projects accrue to debt holders due to the high degree of financial leverage. In such a scenario, equity holders prefer not to invest in such projects as they believe that most of the benefits will go to debt holders rather than themselves. This is known as the under-investment problem.

The Under-Investment Problem Refers to the Problem That Equity Holders