Usually, a lot of people have financial interest in a company's success. The list includes both shareholders and bondholders, as well as groups like employees and even customers. Generally everyone wins when the company does well. But situations arise where the interests of two groups might diverge.
One of these possible points of conflict forms the basis of the asset substitution problem.
Shareholders, or people who have stock in the company (and therefore own it), get paid when the company shows growth. Pushing stock prices higher generally requires earnings and revenue to rise, and the sharper the rise the higher the payout is likely to be. So shareholders generally like the company to take riskier bets, pushing into higher growth areas.
Bondholders, or the people who own bonds issued by the company (also known as people who have lent the company money), get paid regular interest payments. Growth rates don't really impact them that much. They just want the company to remain solvent so they can keep getting their regular coupon payments. So bondholders generally prefer a safer strategy, encouraging management to take a more turtle-like, slow-but-steady approach to corporate strategy.
The asset substitution problem comes up when a company has low-risk assets on the books when it sells a bunch of bonds, but then switches these out for higher-risk assets once it has the money in hand. For this term, don't think of assets as "stuff they own." Think of it more generally as "where their resources are invested."
It would be like saying to your mom, "I know I said we were going to Branson for spring break when you loaned me that money, but we changed our minds. Now we're going to Vegas."
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Finance: What is non-voting stock?4 Views
finance a la shmoop- what is non-voting stock? hmm well it's stock that doesn't
vote. bet you're shocked to hear that. most people need a PhD in finance to [stock wears an "I didn't vote" sticker.
understand that notion. but really that's it in most cases common stock carries
with it the right to vote. and in fact it's the common shareholders who elect
the board of directors. but every now and then a potentially hostile investor
comes along and buys or wants to buy a big chunk of stock in a company. well the
amount might be a block large enough to elect that potentially hostile investor
slate or the group of people that investor wants to place on the board to
represent her evil intentions .when that happens companies will often create a
class of common stock similar in every way to its normal common only with its [stock checklist of privileges listed]
voting rights stripped away .that way the investor can own an economic interest in
the company but not monkey with the board.
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