DEFINITION of 'Underinvestment Problem'
An agency problem where a company refuses to invest in lowrisk assets, in order to maximize their wealth at the cost of the debt holders. Lowrisk projects provide more security for the firm's debt holders, since a steady stream of cash can be generated to pay off the lenders. The safe cash flow does not generate an excess return for the shareholders. As a result, the project is rejected, despite increasing the overall value of the company.
BREAKING DOWN 'Underinvestment Problem'
Shareholders under invest capital by refusing to participate in lowrisk projects. This is similar to the asset substitution problem, where shareholders exchange lowrisk assets for highrisk ones. Both instances will increase shareholder value at the expense of the debt holders. Since highrisk projects have large profits, the shareholders benefit from increased income, as the debt holders require only a fixed portion of cash flow. The problem occurs because the debt holders are not compensated for the additional risk.

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A problem that arises when a company exchanges its lowrisk assets ... 
Agent
1. An individual or firm that places securities transactions ...

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