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Unformatted text preview: the firm. Because this strategy is an after-the-fact approach, other controls
must be included in the loan agreement. Lenders typically protect themselves by
including provisions that limit the firm’s ability to alter significantly its business and
financial risk. These loan provisions tend to center on issues such as the minimum
level of liquidity, asset acquisitions, executive salaries, and dividend payments.
By including appropriate provisions in the loan agreement, the lender can
control the firm’s risk and thus protect itself against the adverse consequences of
this agency problem. Of course, in exchange for incurring agency costs by agreeing to the operating and financial constraints placed on it by the loan provisions,
the firm should benefit by obtaining funds at a lower cost. Asymmetric Information pecking order
A hierarchy of financing that
begins with retained earnings,
which is followed by debt financing and finally external equity
financing. asymmetric information
The situation in which managers
of a firm have more information
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This document was uploaded on 03/30/2014.
- Spring '14