### 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?

#### What does underinvestment mean?

### Further Reading

**Corporate 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 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 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 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 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 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 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 …