ACCA Strategic Professional · Strategic Business Leader · Agency
Karvella plc's lenders hold a covenant-protected loan. The directors, acting for shareholders, propose to use the borrowed funds on a much riskier project than the one the lenders were told about. Which statement best describes the agency issue?
The directors, acting for shareholders, may shift risk onto lenders by choosing a riskier project than disclosed. Shareholders keep the upside while lenders bear the downside, creating an agency conflict between debt holders and shareholders. Lenders respond with covenants and monitoring to protect their position.
- AThe directors, as agents of shareholders, may transfer risk to the lenders, creating a conflict between debt holders and shareholdersCorrect
- BThe directors are acting as stewards and the lenders have no agency concern
- CThe conflict is purely between directors and employees over pay
- DThere is no agency issue because lenders are not principals in any relationship
Explanation
Shareholders gain from the upside of risky projects while lenders bear downside risk. Directors acting for shareholders may therefore shift risk onto lenders, and the lenders rely on covenants and monitoring to protect themselves. Lenders can be viewed as principals who face agency problems with the company's management.
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