Asset substitution problem

Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing assets and expropriate value from the debtholders.

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.
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Johnson, 1997a, 1997b employs the ratio of fixed assets to total assets (FAR) as a proxy for the assets that can be used as collateral to reduce the asset substitution problem associated with debt.
More assets-in-place implies a smaller potential for asset substitution problems, and a lesser need for monitoring (Johnson, 1997a).
Information asymmetry, potential asset substitution problems and monitoring need, concerns of inefficient liquidation, and leverage appear to be among the factors that affect significantly the tradeoff between the costs and benefits of privately negotiated financing.
To the extent that MB is a measure of intangible assets, it could also be a proxy for potential asset substitution problems.
The negative effect of FAR in the "bank" equation suggests that firms with potentially greater asset substitution problems (i.
At the same time, joint incorporation creates an asset substitution problem which does not exist when projects are incorporated separately.
The cost of JI is that it reduces capital structure flexibility and creates an asset substitution problem.
2~, which is the standard asset substitution problem examined in the literature.
We have already discussed how asymmetric taxes tend to mitigate the JI firm's asset substitution problem.
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 fixed asset ratio measures the value of the firm's assets that might be used as collateral in order to mitigate asset substitution problems.
The fixed asset ratio (FAR) measures the value of the firm's assets that might be used as collateral in order to mitigate asset substitution problems.