Final answer:
A firm that adopts a conservative financing policy prioritizes equity financing over debt to minimize risk and maintain operational control, though this may limit growth potential. Such a policy can involve using retained profits or issuing stock, which introduces accountability to shareholders and a board of directors.
Step-by-step explanation:
A firm that adopts a conservative financing policy typically opts for less debt to minimize risk and ensure that it can meet financial obligations without relying heavily on income. Such a policy often involves a higher ratio of equity financing, which might include retaining profits for reinvestment or issuing stock to raise capital.
The drawback of this approach is that it might limit growth potential due to lower levels of leverage. Conservative financing ensures that the firm maintains control of its operations, as it does not increase debt that could potentially be controlled by creditors.
However, a firm may have to deal with shareholders and a board of directors if it chooses to issue stock to avoid taking on debt. The balance that a firm decides upon regarding debt and equity has significant implications for its control, growth potential, and financial stability.