Agency costs of debt
Agency costs of debt arise from shareholder–creditor conflicts under high leverage, including underinvestment and asset substitution. Rising with debt levels, they combine with financial distress costs to cap the optimal use of borrowing.
FrameworkCapital structure theory
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Once debt is substantial, shareholder and creditor interests diverge. Underinvestment happens when a positive-NPV project's gains would mostly flow to creditors, so shareholders decline it despite the value it would create. Asset substitution is the mirror problem: shareholders favour riskier projects because the equity option gains from volatility, shifting expected value away from creditors.
Where it fits
SubjectCorporate FinanceAdvancedTopicCapital Structure & LeverageAdvanced