Chapter 9_ Solutions

Chapter 9_ Solutions - Suggested Solutions to Assigned...

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Suggested Solutions to Assigned Problems in Chapter 9: 4, 9, 11 4. The basic reason for debt covenants is the moral hazard problem between manager and  lender.  As a result, lenders demand a high interest rate to protect themselves from the expected opportunistic manager behaviour (e.g., excessive dividends or additional borrowing). To lower the interest rate demanded, the manager may commit not to engage in this behaviour. Debt covenants based on accounting variables are a credible way to do this since the lender can rely on GAAP and auditing to prevent undue manager interference in the covenant levels. 9. a. The predicted outcome is that both parties play strong. b. Yes, (strong, strong) is a Nash equilibrium. Each player has an incentive to play strong, given that the other player chooses strong. For example, if the standard setter plays strong, the corporations receive a higher payoff from playing strong (12) than playing cooperate (8). Similarly, if the corporations play strong, the standard setter is
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Chapter 9_ Solutions - Suggested Solutions to Assigned...

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