A company will finance itself internally, and then using debts and when these debts are over then the firm will finance through equity by the sales of stock Michael, (2003). Therefore equity financing is as a last option to the company, therefore the company prefers to finance through a chain of financing whereby they utilize available funds.
The use of asset substitution is as a result of an increase in the debt equity ratio. This gives the management the incentive to risk investment in projects. When it happens, there is a decline in the value of the company results in wealth being transferred from the debt to shareholders Ludwig, (2000). When the debts become more risky the underinvestment problem occurs. In the process the profits from the projects will go to debt holders rather than the share holders.
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