When we discuss the role of debt contracts in the context of an institution, we
assume that the manager is the sole owner of the company, or has an interest that is truly in line with the interests of the owner. That is, the principal in this case is a creditor, or lender; an agent is a manager who acts on behalf of shareholders or other owners. Given that company value includes the amount of debt coupled with the value of equity, one way to increase equity value is to increase the value of the company, the other is to transfer wealth from creditors. Smith and Warner acknowledge that the agency problem of debt can lead to four main methods of transferring wealth from debtholders to shareholders: 1. Excessive Dividend Payment The problem of excessive dividend payments arises when the payment of debt lent to the company is assumed to be a certain level of dividend payments. Issuance of higher dividends reduces the asset base to pay off debt and reduce debt value. In extreme situations, management borrows and then pays all borrowed funds in the form of dividends. Shareholders benefit under the scheme because they have received cash, but with limited liability means they are not personally responsible for the debt of the company in the event of bankruptcy. 2. Asset Substitution Asset substitution is based on the premise that lenders do not take risks. They provide loans to companies in the hope that they will not invest in assets or projects of a higher risk than they can. 3. Lack of investment Lack of investment occurs when the owner does not carry out positive NPV projects because doing so will increase the funds available to debtholders, but not to the owner. For example, imagine a company that is facing bankruptcy. The company has a shareholder fund of negative $ 90,000 and the company can invest in projects that will provide a positive NPV of $ 50,000. However, the entire $ 50,000 is recorded to the company's debtholders, not to shareholders. This will reduce the net debt of $ 40,000. Only if the project NPV obtained positively is more than $ 90,000 will maximize the owner's wealth so that it invests in the project. 4. Claim Dilution (Claim Dilution) Dilution claims occur when a company issues a higher priority debt than the debt that has been issued. This increases the funds available to increase company value and ownership value, but reduces the relative security and value of existing debt. This means that there is a dilution of existing debt because the debt has now become more risky with the presence of higher priority debt. Debt agreement requirements are written terms and conditions in debt contracts that limit management activities or require management to take certain actions. Restrictions are designed to protect the interests of debtholders by requiring, for example, that a company maintains a certain level of assets as collateral for debt. The restrictions contained in debt contracts generally consist of one or more than four categories: 1. Agreement requirements that limit the company's production / investment opportunities. These agreement requirements are designed to reduce asset substitution and lack of investment. 2. Terms of agreement to withhold dividend payments and usually bind dividend payments to profits. This agreement prevents excessive dividend payments. 3. Requirements for the agreement to withhold company financing policies. This is aimed at the problem of disbursing claims and usually limiting higher debt 4. Bonding terms of agreement that require companies to provide certain information to lenders, such as reports and disclosures of financial statements to the authorities. This helps bondholders determine whether the terms of the agreement have been violated or are close to the violation.