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 Cumulative Voting?6 Views
Finance, a la shmoop. What is cumulative voting? All right people there are two
flavors of voting in the land of common stock, there's cumulative and statutory. [Two ice cream cones held next to each other]
Cumulative voting just somehow sounds cooler, doesn't it? It allows teams to [Guy points at the ice cream cone and drops it]
join forces and pool their votes cumulatively
for target candidates to get elected that is it allows for the disaggregation,
$5 word there, of board members when voting. That is if a shareholder has one [5 dollar price tag appears]
percent of the common shares outstanding of a company and cumulative voting is [Pie chart showing the small 1% holding]
allowed and there are five candidates being elected, well that shareholder can
vote effectively five percent of their total shares voteable for just one
candidate. Said graphically with blood and guts it looks like this. Cumulative [Table showing shares equalling number of votes per candidate]
voting helps the little guy to have a big presence, with only 1% of the shares [Kid sat at a shareholder meeting]
the little guy can be felt as a 5% holder which makes you know him or her a [Kid jumping to hit a Mario coin box]
relatively major player. It also encourages boards to rotate seats [People swapping seats in the boardroom]
gradually, that is if there were seven seats coming up for election while that
1% could feel like 7% which starts to get dangerous in a contentious board and [The people in the boardroom start fighting]
company situation. You can imagine someone who only owns a small part of
the shares outstanding could elect a whole lot of board. Yeah that'd be a [Wooden boards replace the people in suits]
little scary. Well, score one for the little guy... [Kid laughing will an evil face]
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