CFA Practice Question

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CFA Practice Question

Financial distress arises when the financial obligations of a firm affect the firm's operations. What are some of the possible consequences of financial distress?

A. Debt holders, who face the prospect of getting only part of their money back, are likely to want the company to take additional risks.
B. Equity investors would like the company to cut its dividend payments to conserve cash.
C. Equity investors would like the firm to shift toward riskier lines of business.
D. Equity investors would like the firm to settle up with creditors as fast as possible.
Correct Answer: C

User Contributed Comments 8

User Comment
kalps Surely this is wrong, unless of course the shareholders are those of Enron or Worldcom even
tinku This is correct. Share holders have residual claim. Given the chance the company may go bankrupt they would encourage the management to gamble ie take riskier projects.
rockeR tinku is right. manager will be gambler and sharholders will agree with this.
worst case is losing creditors money only
setmefree agency problem, shareholder v.s debtholder
johnmullrooney stocks turn into call options at this point
endurance another one from kalps..........
fanDango Uh... kalps, this is a very basic question. You should go back to the agency problem that setmefree referenced.
birdperson equity is a call option... equity holders would push for more risk in the face of bankruptcy as getting something is better than nothing! this is of course not at all what the debt holders want...
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