Love is a battlefield...and so is the management of firms.
Take the underinvestment problem, for example: a battle between shareholders and debt holders. Almost every time, the shareholders win...but only in the short-run. In the long-run, everybody loses.
The underinvestment problem is when a firm shoulda/coulda/woulda made an investment that is a clear winner—yet it doesn’t happen, because the firm is already in debt, as it’s “leveraged," and if it took on more debt, then its debt payments would be too high to fill the pockets of shareholders.
If it took on this smart investment, it would be a good thing in the long-run...otherwise, it wouldn’t be a good investment. That means it’d be good for shareholders in the long-run, too. Probably.
But that would take short-term sacrifice, and shareholders are shareholders for their dividends, so...unless shareholders agree to sacrifice short-term payouts for potential long-term benefits, a firm has an underinvestment problem. Remember, the underinvestment problem only happens if a firm is already leveraged, and isn't able to take out equity in the company to do the job instead.
Related or Semi-related Video
Finance: What is an Expected Return?8 Views
Finance, a la shmoop. what is expected return? Okay we've been experimenting for
months on libertarians with cancer in a gwangju prison. Our drug is gonna do one [ man swallows pill]
of three things. A. it may make the prisoners glow in the dark. Not all that
useful as a drug discovery but it would allow investors to sell the company to [man's face glows]
cirque de soleil who would be thrilled to cut down on bodypaint expenses. All
right well if event A happens investors will get at least a 20% return on our [circus performers shown]
money odds of the the glow must go on happening ? 35% . okay moving on. Event B, our
drug may well just kill them - yeah that's a bunch of libertarians in a gwangju
prison. Who's gonna notice, right? in which case investors lose all of their money [money on fire]
and the glow must go on just folds up tent, and goes away. The return there
would be zero. Odds of this happening? Well, 60% yeah
six out of ten. Probably gonna die. okay event C the drug cures cancer! If that [written explanation shown]
happens while investors get a thousand percent return on their money .Save the
world and in general improve their tinder match ratio by like a zillion.
Odds of this happening, well just 5% but hey it's worth a shot right?
So our adjusted probability chart looks like- this - see we got return and odds and [chart shown]
expect the case 2035, 7 yeah there we go.
So what is all this telling us ? Well that the overall expected return - yeah you
knew we'd get there eventually - is a 57% return on our investment. Great return!
bottom line do it the chance of curing cancer would be well worth the risk. And [people dance]
if not well at least there would be fewer bicycling accidents.
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