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Unformatted text preview: ts financial leverage and
risk. Financial risk depends on the capital structure decision made by the management, and that decision is affected by the business risk the firm faces. The
total risk of a firm—business and financial risk combined—determines its probability of bankruptcy. Agency Costs Imposed by Lenders
As noted in Chapter 1, the managers of firms typically act as agents of the owners
(stockholders). The owners give the managers the authority to manage the firm
for the owners’ benefit. The agency problem created by this relationship extends
not only to the relationship between owners and managers but also to the relationship between owners and lenders.
When a lender provides funds to a firm, the interest rate charged is based on
the lender’s assessment of the firm’s risk. The lender–borrower relationship,
therefore, depends on the lender’s expectations for the firm’s subsequent behavior. The borrowing rates are, in effect, locked in when the loans are negotiated.
After obtaining a loan at a cert...
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This document was uploaded on 03/30/2014.
- Spring '14