Asset substitution

Asset substitution

Occurs when a firm invests in assets that are riskier than those that the debtholders expected.

Asset Substitution

A company's exchange of lower-risk investments for higher-risk investments. Firms may use asset substitution as a form of financing, or as a move to please shareholders. It can be detrimental to the company's bondholders as it increases the possibility of default without any corresponding benefit because bonds have a fixed interest rate. On the other hand, asset substitution can benefit shareholders as it carries the possibility of higher returns.
References in periodicals archive ?
In Chapter 7, two classic agency problems are considered: the asset substitution problem where the investors do not know whether the firm invests in the riskier project or not, and the underinvestment problem, where the conflict between shareholders and bondholders results from the sharing of the benefits of a new project, even when this is appropriately valued in financial markets.
The new Asset Substitution Product gives qualified borrowers a unique advantage.
More assets-in-place implies a smaller potential for asset substitution problems, and a lesser need for monitoring (Johnson, 1997a).
In that literature, it is said to take two key forms: currency substitution is the use of foreign currency as a means of payment for transactions; and asset substitution is the use of foreign currency denominated assets as a store of value.
6330(c)(2)(A), the taxpayer may raise any relevant collection issues at the Appeals hearing, including the propriety of the IRS's intended collection action, spousal defenses and possible alternatives (including asset substitution, an installment agreement or an offer in compromise).
As Grinblatt and Titman (1998) argue, smaller firms may have greater flexibility to engage in asset substitution and also greater top management ownership shares, on average.
Risky assets are relatively attractive because investors can default in low payoff states, so there is asset substitution and prices are bid up.
In addition to the asset substitution problem between shareholders and creditors, shareholders may choose not to invest in profitable projects (underinvest) if they believe they would have to share the returns with creditors.
Two important manifestations of these agency problems are asset substitution and information asymmetry.
In estimating the asset substitution equation (11), the ratio of user costs in money holding [M.
Johnson (1997a) and Johnson (1997b) employ the ratio of fixed assets to total assets as a proxy for the assets that can be used as collateral to reduce the asset substitution problem.
The dollarisation literature is replete with normative discussions concerning the wisdom of official dollarisation, but has suffered from a fundamental empirical problem when attempting to assess positive issues concerning the causes, consequences, costs and benefits of currency, and asset substitution.