Module 9: Long Answer Questions

For students

Last updated: 08/01/2026 17:54

The questions are based on or inspired by the following references:

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📙 Part 2 (Midterm to Final)

Module	Chapter
9	ch16

Answer the following questions based on the discussions in class.

Q1.

Discuss how financial distress costs affect the firm’s optimal capital structure according to the trade-off theory. Provide examples of both direct and indirect costs of distress.

Q2.

Explain the agency costs of leverage and how they influence managerial and shareholder behavior during periods of financial distress. Illustrate with an example of risk-shifting or debt overhang.

Q3.

Explain how leverage can reduce managerial entrenchment and improve managerial incentives. Discuss the mechanisms through which debt can align managers’ interests with those of shareholders and creditors.

Q4.

Discuss how asymmetric information affects capital structure decisions. How do signaling and the pecking order theory explain managers’ preferences between internal financing, debt, and equity?

Q5.

Integrate the concepts of taxes, financial distress, and agency problems into a unified view of the trade-off theory. What does this integrated framework imply about the existence of an optimal capital structure?

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