ACCA Advanced Financial Management (AFM) Practice Exam

Debt holders have privileged rights to which aspect of a corporation?

1. Decision-making in corporate governance

2. Cash flows

3. Ownership stakes

4. Asset liquidation proceeds

The correct answer is: Cash flows

Debt holders have privileged rights primarily to cash flows. When a company takes on debt, it agrees to pay interest and eventually repay the principal amount to the lenders. These payments are prioritized over distributions to equity holders, meaning that debt holders have a legal claim to the cash flows generated by the company before shareholders receive any distributions. This secured position ensures that, regardless of the company's profitability, debt obligations must be fulfilled, making cash flow rights a critical aspect of the relationship between a corporation and its debt holders. In the context of corporate governance, while debt holders may have some influence through covenants or agreements, they do not generally participate in decision-making processes like equity holders do. Ownership stakes pertain specifically to equity holders, who have claims to the residual value of the company after all obligations, including those to debt holders, have been met. Finally, although debt holders do have rights in the event of liquidation, their primary privilege relates to cash flows during normal operations, as they must be paid regularly regardless of the company's situation.