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    Restrictive covenants improve bond ratings? Agency theory.

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    Using agency theory concepts, explain how restrictive covenants that forbid leases and liens on a firm's assets might cause the firm to achieve a higher rating on its bonds than would be possible without such covenants.

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    Agency theory argues problems arise when one party assigns the task and the other does the work. In this case, the bondholder (principle) is assigning the task (operate the business and generate positive operating cash flows to enable bond repayment) and the bond issuer is the agent in charge of carrying out the task. If the bondholders do not insist on certain rules, the agent has an incentive to take on more risk in order to maximize their returns (self-interested goals), even if the risks jeopardize the bond ...

    Solution Summary

    Your tutorial is 332 words plus a references and explains how leases are claims against cash flows and obligate the business just like debt.