In the context of agency costs, what might shareholders in a leveraged firm prioritize that could negatively impact debt?

In the context of agency costs, shareholders in a leveraged firm might prioritize adopting investment strategies that elevate shareholder value. This focus can lead to decisions that favor their interests over those of debt holders. When shareholders aim to maximize their potential returns, they may engage in riskier projects or investments that promise high rewards, which can increase the likelihood of default on debt obligations.

In a leveraged situation, the presence of debt already carries the risk of financial distress, so if shareholders push for aggressive strategies that put the firm’s stability at risk, this can exacerbate debt holders' concerns. Their priority on elevating shareholder value can result in capital structures and investment choices that neglect the need to maintain an appropriate balance between risk and return, potentially harming the interests of creditors by increasing agency costs associated with risk-taking behavior.

For instance, a leveraged firm might undertake highly speculative investments, believing that if the investment pays off, the potential gains will benefit shareholders disproportionately while the losses—if incurred—are absorbed primarily by debt holders. Thus, the pursuit of strategies aimed solely at maximizing shareholder value can inadvertently lead to actions that harm the firm's creditworthiness and financial stability.