When is a firm more likely to engage in excessively risky behaviors, w

When is a firm more likely to engage in excessively risky behaviors, when business is well, or when it is facing financial distress?

What will be an ideal response?

ANSWER

Financial distress is a cause of moral hazard. Even heretofore prudent managers are tempted to take drastic action with the hope that a big payoff might save the company, and the realization that, if the company is about to fail, there’s little to lose by taking big risks. Moreover, managers are understandably reluctant to reveal bad news, and the move away from transparency encourages behaviors that would be dismissed as unacceptable if they were easily observable.