With associated adverse effects on lenders employees

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with associated adverse effects on lenders, employees, suppliers, and customers, which causes them to contract with the firm at less favorable terms - may require the firm to raise costly external funds and forgo profitable investment opportunities - may reduce expected tax shields and sacrifice advantages to insurance bundling Several characteristics impact the cost of retention: Characteristic Impact a) Closely held vs. publicly traded firms - owners of closely held firms typically have a large investment in firm and have an incentive to retain less risk (purchase more insurance) b) Firm Size and correlation among losses - if a firm has a large number of independent exposures, then the firm can predict its average loss per exposure more accurately; positive correlation among losses reduces the extent to which firms can diversify internally c) Investments - firms that finance investments are likely to reduce risk d) Product characteristic - firms in industries vulnerable to consumers’ perceptions of bankruptcy retain less risk and benefit more from risk reduction e) Correlation of losses with other cash flows - firms whose losses are positively correlated with other cash inflows will have a lower standard deviation of total cash flows, and retain more risk f) Financial leverage - firms with higher debt-to-equity ratios will have a higher likelihood of financial distress; higher leverage = higher fixed costs from interest
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