Given this it is likely that each household would

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Unformatted text preview: Given this, it is likely that each household would prefer to leave the monitoring to others; in the end, little or no monitoring would be done. The resulting lack of monitoring would reduce the attractiveness and increase the risk of investing in corporate debt and equity. In the real world, bondholders partially alleviate these problems by requiring restrictive clauses or covenants in bond contracts. Such covenants restrict the risky nature of projects that a firm’s management can undertake. Bondholders also hire a bond trustee to oversee compliance with these covenants. However, the enforcement and monitoring of covenants are still quite costly, especially if the debt is long term and is renewed infrequently. The relatively long-term nature of corporate equity and debt also creates a second disincentive for household investors to hold the direct financial claims issued by corporations. Specifically, given the choice between holding cash and holding long-term securities, households may well choose to hold cash for liquidity reasons, especially if they plan to use savings to finance consumption expenditures in the near futu...
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