company. But as becomes clear from Deegan & Unerman the market bonus schemes have both upsides and downsides. One of the downsides is that the financial markets do not value the expenses made for research and development as value increasing expenses and are therefore not represented in the share price. This may result in a cut in research and development expenses in order to influence the share price. A second downsides is that managers may not always be able to influence the share price due to changes in the overall market. A further downside is that it could be that company earnings may be viewed as less positive (more negative) in light of overall market wide movements in equity values. The advantage of the market bonus scheme is that managers with an equity interest will be more willing to disclose more information about the company and its performance and perspectives. This results in a situation of more information symmetry between the managers and the owners. Debt contracting Besides the contract between the manager and the shareholder, the company may engage in a contract with an external party willing to lend the company funds for their operations. As with the relation between the manager and the shareholder, the lender carries risk that of non-repayment due to manager actions. This may occur when the company uses the money for additional dividend payouts to the shareholders or investments in high risk projects. The costs related to divergent behaviour of the borrower are referred to as the agency costs of debt in the PAT. According to the PAT it is assumed that, in the absence of safeguards to protect the lender, the manager will not take those actions that are in the best interest of the lender. Due to this it is assumed that the company will have to pay higher costs of interest to compensate the lender for the high risk exposure. The company has the possibility to reduce the higher costs of interest if it is willing to engage in a debt agreement declaring that they will not use the received funds for activities such as mentioned before i.e. agreement upon certain constraints. By doing so it will reduce its interest costs and the lender risk. Examples of the debt constraints are leverage covenants, a minimum interest coverage and a minimum current ratio.
company. But as becomes clear from Deegan & Unerman the market bonus schemes have both upsides and downsides. One of the downsides is that the financial markets do not value the expenses made for research and development as value increasing expenses and are therefore not represented in the share price. This may result in a cut in research and development expenses in order to influence the share price. A second downsides is that managers may not always be able to influence the share price due to changes in the overall market. A further downside is that it could be that company earnings may be viewed as less positive (more negative) in light of overall market wide movements in equity values. The advantage of the market bonus scheme is that managers with an equity interest will be more willing to disclose more information about the company and its performance and perspectives. This results in a situation of more information symmetry between the managers and the owners. Debt contracting Besides the contract between the manager and the shareholder, the company may engage in a contract with an external party willing to lend the company funds for their operations. As with the relation between the manager and the shareholder, the lender carries risk that of non-repayment due to manager actions. This may occur when the company uses the money for additional dividend payouts to the shareholders or investments in high risk projects. The costs related to divergent behaviour of the borrower are referred to as the agency costs of debt in the PAT. According to the PAT it is assumed that, in the absence of safeguards to protect the lender, the manager will not take those actions that are in the best interest of the lender. Due to this it is assumed that the company will have to pay higher costs of interest to compensate the lender for the high risk exposure. The company has the possibility to reduce the higher costs of interest if it is willing to engage in a debt agreement declaring that they will not use the received funds for activities such as mentioned before i.e. agreement upon certain constraints. By doing so it will reduce its interest costs and the lender risk. Examples of the debt constraints are leverage covenants, a minimum interest coverage and a minimum current ratio.