Underinvestment Problem
 |
Definition of 'Underinvestment Problem'An agency problem where a company refuses to invest in low-risk assets, in order to maximize their wealth at the cost of the debt holders. Low-risk 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. |
 |
Investopedia explains 'Underinvestment Problem'Shareholders under invest capital by refusing to participate in low-risk projects. This is similar to the asset substitution problem, where shareholders exchange low-risk assets for high-risk ones. Both instances will increase shareholder value at the expense of the debt holders. Since high-risk 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. |
Related Definitions
Articles Of Interest
-
Governance Pays
Learn about how the way a company keeps its management in check can affect the bottom line. -
The Basics Of Corporate Structure
CEOs, CFOs, presidents and vice presidents: learn how to tell the difference. -
Who is responsible for protecting and managing shareholders' interests?
The average shareholder, who is typically not involved in the day-to-day operations of the company, relies on several parties to protect and further his or her interests. These parties include ... -
Pay Attention To The Proxy Statement
Don't overlook this overview of a company's well-being. -
How Risk Free Is The Risk-Free Rate Of Return?
This rate is rarely questioned - unless the economy falls into disarray. -
Top 4 Most Scandalous Insider Trading Debacles
Here we look at some of the landmark incidents of insider trading. -
Nobel Winners Are Economic Prizes
Before you try to profit from their theories, you should learn about the creators themselves. -
Lessons On Corporate Dividend Payout And Retention Ratio
Why are dividend payout and retention ratios important to consider when investing in company stock? What companies have high ratios?What constitutes a high dividend payout and retention ratio? ... -
Conglomerates: Cash Cows Or Corporate Chaos?
Huge companies may not be as infallible as previously assumed. Find out why bigger isn't always better. -
Cashing In On Corporate Restructuring
Companies use M&As and spinoffs to boost profits - learn how you can do the same.
Free Annual Reports