Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders? a. Compensating managers with stock options. b. Abolishing the Security and Exchange Commission. c. The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. d. Financing risky projects with additional debt. e. The threat of hostile takeovers.
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A conflict of interest occurs when a person or entity has two relationships contending for the individual's allegiance. For example, the individual may be devoted to both an employment and a family company. Each of these companies expects the individual to put the company's interests first. Thus a conflict of interest occurs when a person prioritizes personal gain over responsibilities to an organization in which they have a stake, or when they use their position for personal gain in some way. All corporate board members have fiduciary responsibilities as well as a duty of loyalty to the companies they oversee.
Agency conflict between debtholders and stockholders will reflect that stockholders are not acting in the best interests of debt holders and will undertake various types of projects that are highly risky or they will pay themselves a higher amount of dividend which will reduce the company's liquidity and profitability, so debt holders face a risk associated with complete discharge of their debt payment. As debt holders are creditors of the firm and shareholders are owners of the company, debt holders will send funds to shareholders to manage, and if shareholders do not manage the funds in the best interests of the debt holders, there will be an agency conflict.
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