Asset Substitution Problem

AAA

DEFINITION of 'Asset Substitution Problem'

A problem that arises when a company exchanges its low-risk assets for high-risk investments. This substitution transfers value from a firm's bondholders to its shareholders.

INVESTOPEDIA EXPLAINS 'Asset Substitution Problem'

The transfer of assets places more risk on the debt holders without providing them with additional compensation. High-risk projects can yield higher profits, however more risk is incurred by the firm. The added profit may only benefit the shareholders, as the bondholders require only a fixed return. The increase level of risk does affect the bondholders, since the company increases its chance of defaulting on its debt.

RELATED TERMS
  1. Substitution Effect

    The idea that as prices rise (or incomes decrease) consumers ...
  2. Agency Costs

    A type of internal cost that arises from, or must be paid to, ...
  3. Agency Problem

    A conflict of interest inherent in any relationship where one ...
  4. Agency Theory

    A supposition that explains the relationship between principals ...
  5. Corporate Governance

    The system of rules, practices and processes by which a company ...
  6. Default

    1. The failure to promptly pay interest or principal when due. ...
Related Articles
  1. The Basics Of Corporate Structure
    Investing Basics

    The Basics Of Corporate Structure

  2. What Are Corporate Actions?
    Bonds & Fixed Income

    What Are Corporate Actions?

  3. Governance Pays
    Options & Futures

    Governance Pays

  4. Who is responsible for protecting and ...
    Investing

    Who is responsible for protecting and ...

comments powered by Disqus
Hot Definitions
  1. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  2. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  3. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  4. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  5. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
  6. Limit-On-Open Order - LOO

    A type of limit order to buy or sell shares at the market open if the market price meets the limit condition. This type of ...
Trading Center