What is the meaning of A in the following. I did not understand bonding insurance and its relationship with management performance Which of the following is least likely to be categorized as a cost of financial distress? A) Premiums paid for bonding insurance to guarantee management performance. B) Having a potential merger partner pull out of a proposed deal. C) Inability to refinance outstanding debt. D) Legal fees paid to bankruptcy lawyers. Your answer: B was incorrect. The correct answer was A) Premiums paid for bonding insurance to guarantee management performance. Premiums paid for bonding insurance to guarantee management performance is an example of an agency cost. Agency costs are costs associated with the fact that all public companies are not managed by owners and the conflict of interest created by that fact. Costs of financial distress can be direct or indirect. Direct costs would include cash expenses associated with bankruptcy, such as legal and administrative fees, while indirect costs would include foregone business opportunities, inability to access capital markets, or loss of trust from customers, suppliers, or employees.
Cost of financial distress is when the company is filing for bankruptcy, so all the litigation charges, admin fees, court fees, lawyer fees are the tangible costs. ‘A’ looks like it’s an amount which the company puts down to avoid the principal agent problem so as the have the mgmt align to the common goal.
Hi, I made the same mistake in beginning. then on curriculum 3, page 124, example 10, CFAI listed a few typical examples on cost of distress. partner pulling out of the merger is one of them… you might wanna take a look at it.
This would be like a bond required for a pension plan fiduciary. If the fiduciary up and runs out of town with all the money, the bonding company has to pay the employees for their losses. Principal-Agent thing as Dinesh described.