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Do shareholders really prefer risky projects?

Gong, Ning 2004, Do shareholders really prefer risky projects?, Australian journal of management, vol. 29, no. 2, pp. 169-187, doi: 10.1177/031289620402900202.

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Title Do shareholders really prefer risky projects?
Author(s) Gong, Ning
Journal name Australian journal of management
Volume number 29
Issue number 2
Start page 169
End page 187
Total pages 20
Publisher Sage
Place of publication London, Eng.
Publication date 2004-12
ISSN 0312-8962
Summary It is often argued that managers representing shareholders' interests tend to undertake risky projects because equity resembles a call option on a firm's assets. However, this conclusion is not generally true when bankruptcy risk is explicitly modelled. This paper compares the relative strength of the agency cost and the bankruptcy risk in determining managerial choice of cash-flow volatility in a continuous-time framework. Assume the existing debt has covenants which preclude additional borrowing and that bankruptcy is triggered when the cash balance hits zero, I show that for low levels of debt, shareholders prefer to minimize cash-flow volatility I also work out the critical face value of the debt above which shareholders are risk-seeking rather than risk-avoiding In short, bankruptcy costs being borne by equity mitigates shareholders' desire for risk.
Language eng
DOI 10.1177/031289620402900202
Field of Research 150201 Finance
Socio Economic Objective 910102 Demography
HERDC Research category C1.1 Refereed article in a scholarly journal
ERA Research output type C Journal article
Copyright notice ©2004, The Australian Graduate School of Management
Persistent URL http://hdl.handle.net/10536/DRO/DU:30088523

Document type: Journal Article
Collection: Department of Finance
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