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CFA Level I · CFA Level I Exam · Investors and Other Stakeholders

A company is nearing financial distress. Which stakeholder is most likely to prefer that management take on a high-risk, high-variance investment, compared with the other stakeholders listed?

Shareholders are most likely to prefer the high-risk investment. Their equity resembles an option near distress, so extra variance raises its value while losses are limited to what is already nearly gone. Creditors, whether trade or secured, want asset value preserved and therefore oppose gambling.

  1. ATrade creditors owed payment within 30 days
  2. BShareholders, whose equity may otherwise be worthlessCorrect
  3. CSenior bondholders with collateral on the firm's plant

Explanation

Near distress, equity resembles a call option: shareholders lose little more if the project fails but capture upside if it succeeds, so they favor risk. Creditors want preservation of asset value to secure repayment, so they prefer lower risk.

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