Linking the Moral Hazard and Leverage in Companies

This paper is intended to fill the gap in the literature on moral hazard amongst companies. It seeks to explore the moral hazard for companies by linking the leverage range with the risk involuntarily assumed by third parties. The paper takes the distinctive approach of trying to understand the nature of the moral hazard affected not only through asymmetries but also through lack of resources in companies. The paper also seeks to establish the importance of companies' moral hazard from an ethical perspective and proposes an index –the moral hazard index– which provides the option of reducing risk when managers make (moral) decisions on leverage and equity levels; subsequently the assumed risk is controlled. An extreme case is set out of companies that have such high leverage that they survive with negative equity (sometimes also known as zombie companies). In such cases the assumption of risk by third parties is undeniable. The paper explains the problem and shows the concern regarding company leverage. Although the index is still only theoretical, it offers opportunities for improvement to determine its applications and utility. Moral decisions are expected to be taken with regard to the structure of the capital of companies in order to reduce the risk assumed by third parties.