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Underinvestment Problem

Underinvestment Problem

What is an 'Underinvestment Problem'

An underinvestment problem is 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.

Explaining '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.


Underinvestment Problem FAQ

What is the underinvestment problem?

The underinvestment issue is an agency issue proposed by economist specialists that exist among investors and shareholders, where a leverage organization foregoes important investment openings since its debt-holders would be entitled to a portion of the returns on the said investments leaving inadequate returns for the company.

What does underinvestment mean?

Underinvestment means an insufficient amount of investment.

Further Reading

Corporate insurance and the underinvestment problemCorporate insurance and the underinvestment problem
www.jstor.org [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

The underinvestment problem and corporate derivatives useThe underinvestment problem and corporate derivatives use
www.jstor.org [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

The underinvestment problem, bond covenants, and insuranceThe underinvestment problem, bond covenants, and insurance
www.jstor.org [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

The underinvestment problem and patterns in bank lendingThe underinvestment problem and patterns in bank lending
www.sciencedirect.com [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

Off-balance sheet activities and the underinvestment problem in bankingOff-balance sheet activities and the underinvestment problem in banking
books.google.com [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

The underinvestment and overinvestment hypotheses: an analysis using panel dataThe underinvestment and overinvestment hypotheses: an analysis using panel data
onlinelibrary.wiley.com [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …

Corporate insurance and the underinvestment problem: an extensionCorporate insurance and the underinvestment problem: an extension
www.jstor.org [PDF]
… example, bond covenants that restrict dividend payments can help control the underinvest- ment problem … The insurance policy has solved the underinvestment problem while allowing the firm to have $500 of … off as little as $101 would also control the incentive problem when the …


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Section 508

WCAG 2.0

Section 508