1.4 Shareholders have limited liability, but receive all the returns after the fixed payments to the bondholders are made. After obtaining funds from bondholders, the shareholders may seek to make more risky investments because they can benefit without limit, but the bondholders are still limited to the returns that have already been fixed.

These conflicts are resolved in two ways. The contract for obtaining funds (called the bond indenture) will have written provisions (called covenants) restricting the ability of the shareholders (or managers) from taking actions that increase the risks to bondholders. The second protection to bondholders is that they may require a high rate of interest in advance because of the risk that the bond covenants may not fully anticipate all the ways that the shareholders may take actions adverse to the bondholders.