Under the debt hypothesis:
A) managers prefer to have more remuneration.
B) managers' interests are more aligned with those of lenders than with those of shareholders.
C) managers of entities with high leverage are likely to choose accounting policies that increase profit and equity.
D) managers do not have discretion in choosing accounting policies.

Question

Quizplus · Accepted Answer

According to the debt hypothesis, managers of highly leveraged entities are incentivized to use accounting policies that increase profits and equity in order to signal financial health to lenders and maintain access to credit. This is because lenders are considered to have more power over the firm than shareholders, and the interests of lenders and managers are more aligned under this hypothesis. Thus, the correct choice is C.

Under the Debt Hypothesis