Deck 24: Corporate Governance

Question 1

Which of the following statements is true?

A)Companies can have high growth, yet negative stock returns.
B)A major safeguard against management's undertaking a project that is not in shareholders' best interest is the need to raise capital to fund the project.
C)The older the firm, the more well-structured it is, and corporate control is better than it is for a newly established firm.
D)Giving stock options to management eliminates agency conflicts.

Answer 1

Companies can have high growth, yet negative stock returns.

Question 2

A likely reason that managers of U.S. firms earn so much more than their European and Japanese counterparts is that

A)the cultural, ethical, and legal constraints in Europe and Japan prevent too high a salary being paid; the social norms and laws are different in the U.S.
B)managerial talent is harder to find in the U.S. than in Europe and Japan.
C)shareholders in European and Japanese companies play a more active role in corporate governance.
D)a larger salary is necessary to attract and retain top CEOs in the U.S. than it is in Europe and Japan.

Answer 2

the cultural, ethical, and legal constraints in Europe and Japan prevent too high a salary being paid; the social norms and laws are different in the U.S.

Question 3

Which of the following illegal actions is hardest to detect and prove?

A)transfers of corporate resources for personal benefit
B)accepting bribes
C)earnings manipulation
D)insider trading

Answer 3

accepting bribes

Question 4

You want to open a business that will require you to raise $5 million . If undertaken, the present value of the business is $20 million. If potential equity investors believe that you will
Behave opportunistically and award yourself an excessive salary of $2,000,000, what
Percentage ownership will they require in order to invest the $5 million in your idea? Round
Your answer to the nearest tenth of a percent.

A)25.0%
B)27.8%
C)33.3%
D)15.0%

Question 5

Which of the following actions would be considered illegal?

A)A CEO orders a new corporate jet , so that she can fly separately from the other executives of the firm and take her dog with her, even though the firm is currently financially
Distressed.
B)The management of a firm that is a hostile takeover target due to poor management issues massive amounts of debt to fight against it.
C)The executive managers of a firm each received a 30% bonus in a year in which their firm lost 50% of its value.
D)Rather than using a competitive underwriting, the CEO of a small, publicly traded, brokerage firm gives the contract for a new issue of the firm's debt to an investment
Banking firm that has agreed to allocate extra shares of its IPOs to her.

Question 6

Which of the following statements is true?

A)Incredibly, nepotism tends to be in shareholders' best interest.
B)If a firm is enjoying a period of profitability and its profits is are being expropriated by its employees, management's best course of action may be to sell off the firm's assets and
Return the funds to its investors.
C)The management of dying companies should focus on selling off the firm's assets and returning the funds to its investors; the management of healthy companies should focus on
Growing bigger.
D)Managers who wish to increase shareholder wealth will seek to grow, or at least prevent shrinking, their firm's business.

Question 7

Which of the following statements is true?

A)It is better for shareholders if management errs on the side of conservatism when reporting its earnings.
B)Laws preventing insider trading are in the best interest of the external shareholders of the firm.
C)Insider trading is always illegal, but there are legal ways in which management may manipulate the earnings it reports.
D)Both insider trading and earnings manipulation may be either legal or illegal, depending on whether certain guidelines are followed.

Question 8

The highest agency costs in U.S. companies are thought to be due to

A)empire building.
B)fraud.
C)insider trading.
D)earnings manipulation.

Question 9

Are younger or older firms more likely to have weaker corporate governance
mechanisms? Why?

Question 10

What is meant by the term "agency problem" in the context of a corporation?

Question 11

Empirical evidence indicates that legal accounting earnings manipulation is particularly aggressive

A)just before the firm seeks new debt financing.
B)when management is trying to fend off a hostile takeover.
C)in the last quarter of the firm's fiscal year.
D)just before a firm issues new equity.

Question 12

Which of the following statements is (are)true?

A)It is not in investors' best interest to have measures in place that would eliminate all agency conflicts.
B)Good corporate governance is synonymous with good management.
C)The control rights of both the bondholders and the shareholders lie in their ability to elect members of the firm's board of directors.
D)All of the above are true statements.

Question 13

Managers of older, cash cow, publicly traded companies

A)have the same incentive to control agency problems as the owner-entrepreneur--i.e., the ability to raise capital on reasonably good terms.
B)have little or no incentive to control agency problems.
C)sometimes expropriate value from existing shareholders to increase their own wealth.
D)both B and C.

Question 14

"Tunneling" refers to

A)the use of illegal accounting practices to paint a rosier picture than what exists.
B)bribes to corporate executives by those seeking to win corporate business contracts.
C)the transfer of corporate assets to an insider.
D)the use of legal accounting practices to make investors focus on the bottom line without considering the inputs to the bottom line.

Question 15

The control rights of the shareholders of a firm lie in

A)their ability to elect some members to the board of directors.
B)their ability to sell their shares if they are unhappy.
C)their ability to fire managers at will.
D)their ability to force the firm into bankruptcy for non-payment of dividends.

Question 16

You have a project that will require you to raise $1 million. The NPV of the project is $10 million. If potential equity investors believe that you will behave opportunistically and award
Yourself an excessive of $500,000, how much of the firm will you have to sell in order to raise
The needed funds with new equity? Round your answer to the nearest tenth of a percent.

A)15.1%
B)5.0%
C)10.5%
D)10.0%

Question 17

The entrenched management of a $200 million, all-equity-financed firm has identified a project that costs $60 million and will return $50 million in today's dollars, after the managers
Load their own pockets. If management issues more shares to finance this project, what will be
The value of the old shareholders' interest in the firm? (Assume the new shareholders are naïve
And do not fear similar expropriation in the future).

A)$200 million
B)$190 million
C)$154 million
D)$175 million

Question 18

A major incentive for the owner entrepreneur to control agency problems is

A)the ability to avoid using debt financing.
B)the avoidance of penalties inflicted by the SEC for not doing so.
C)the ability to raise capital on reasonably good terms.
D)the ability to protect the interests of future investors in the firm.

Question 19

Which of the following statements is true?

A)The existence of bondholder control rights can ultimately result in an increase in the value of the firm's equity.
B)Although there is a conflict of interest between creditors and stockholders, stockholders, in general, tend to agree on what is in their collective best interest.
C)Conflicts of interest exist between the management of a firm and its investors, but the investors'--both debtholders and stockholders--interests tend to be almost perfectly
Aligned.
D)None of the above is a true statement.

Question 20

The entrenched management of a $300 million, all-equity-financed company has identified a project that will cost $80 million and will return $50 million in a year after they siphon off the
Cream for themselves. If the firm finances the project with new equity and the firm's cost of
Capital is 10%, what will be the value of the old shareholders' investment afterwards? Assume
The new shareholders are naïve and do not fear similar expropriation by management in the
Future. Round your answer to the nearest tenth of a million dollars.

A)$256.6 million
B)$276.2 million
C)$265.3 million
D)$293.0 million

Question 21

Does the empirical evidence suggest that managers of publicly traded U.S. firms are
overpaid or fairly paid? Explain.

Question 22

Which of the following would be a violation of management's fiduciary responsibility to its shareholders?

A)In its efforts to expand internationally, which it believes will enable it to increase its profitability, a cable company lays cables throughout a third world country, only to have
Its underground assets expropriated by the government of that country.
B)Management agrees to acquire a small firm that is owned by one of its board members and that manufactures a product that is similar to its own product line, basing its decision on
That member's NPV analysis of his business.
C)Management undertakes a project that turns out to be a loser, even though they had concluded it was a positive-NPV project before they undertook it.
D)All of the above will erode shareholders' wealth and are, therefore, violations of management's fiduciary responsibility to its shareholders.

Question 23

Which of the following statements about corporate boards in the U.S. is (are)true?

A)The chairman of the board is responsible for setting the meeting agendas and requesting necessary information from the firm's management.
B)Being a member of a board of directors is a full time job, often requiring 80 hours or more a week.
C)Outside directors may not have any role within the company itself and may not have any type of relationship to the CEO of the company either.
D)In most corporations, the positions of CEO and chairman of the board are separate.

Question 24

Based on studies of publicly traded firms that became privately held,

A)managers of publicly traded firms are grossly overpaid, but are also penalized harshly for bad performance.
B)managers of publicly traded firms are not paid enough for good performance, and they are penalized harshly for bad performance.
C)managers of publicly traded firms are grossly overpaid and are not penalized enough for bad performance.
D)managers of publicly traded firms are not paid enough for good performance, and they are not penalized enough for bad performance.

Question 25

The term "efficiency wage" refers to

A)the lowest salary at which a CEO can be hired.
B)the amount that a CEO is paid as motivation to work toward the firm's future, to avoid making mistakes, and to not defect to the competition.
C)the amount that a CEO earns above the amount that it would actually take to keep her.
D)none of the above.

Question 26

Executive stock options are generally awarded based on

A)the percentage increase in the firm's revenues.
B)the stock price of the firm.
C)the percentage growth rate in the firm's earnings.
D)how well the firm performed relative to its industry peers.

Question 27

European and Japanese CEOs of successful corporations earn only about what percent of the salary of a CEO of a comparable U.S. firm?

A)5%
B)20%
C)10%
D)15%

Question 28

Which of the following statements about the influence of large shareholders is (are)true?

A)Institutional investors, such as mutual funds, exert control over management, and small, retail shareholders benefit.
B)Most large institutional shareholders avoid actively seeking corporate influence in order to avoid insider trading violations.
C)Of the large institutional investors, only public pension funds tend to exert control over management to the benefit of small, retail shareholders.
D)Both B and C are true statements.

Question 29

Individual shareholders typically do not band together to oust a bad board of directors due to

A)their belief that the free market system will correct the problem.
B)lack of knowledge that the board is behaving badly.
C)the high costs--both direct and indirect--of coordinating the effort for any individual or group of individual shareholders.
D)bribes received from management.

Question 30

When individuals act in their own personal best interest, doing nothing due to the time involved, and hope that other individuals will band together to solve a problem that they all
Face, it is referred to as

A)the silent majority.
B)the tragedy of the commons.
C)small stakeholder apathy.
D)shareholder acquiescence.

Question 31

Which of the following statements is true?

A)Creditors can force a firm into bankruptcy if a firm is found in violation of any of its covenants.
B)Creditor expropriation is more common in Germany than in the U.S.
C)Management tries to avoid filing for bankruptcy protection mainly because it is not in the best interest of its shareholders.
D)Creditors can force a firm into bankruptcy only if a firm misses payments on its debt obligations.

Question 32

Which of the following is not a method by which management is able to manipulate bond covenants to the detriment of the bondholders?

A)divisional splits
B)bankruptcy
C)issuance of convertible bonds
D)forced exchange offer

Question 33

How can bond covenants indirectly benefit a firm's shareholders?

Question 34

The structure of many executive compensation packages is due to

A)the desire to pay large amounts, but hide this fact from the public.
B)shareholder apathy.
C)the desire to incentivize management.
D)the board's adherence to its fiduciary responsibility to the shareholders.

Question 35

All else equal, the ability of U.S. companies to file for Chapter 11 protection

A)serves to make debt more expensive than it otherwise would be.
B)allows U.S. firms to delay turning over its assets to creditors.
C)makes liquidation almost instantaneous when bond covenants are violated.
D)Both A and B are true statements.

Question 36

Most of the rules under which both public and private firms operate in the U.S. are

A)the individual firm's corporate bylaws.
B)federal government regulations.
C)SEC regulations.
D)individual state laws.

Question 37

Most corporate boards in the U.S. are

A)effective control mechanisms and work hard to protect the interests of the shareholders.
B)comprised mostly of inside directors.
C)totally useless since they have strong ties to the management of the firm.
D)useful control mechanisms under some circumstances and also serve useful non-control functions.

Question 38

True, False, or Uncertain: For all of its negatives, bureaucracy is a strong corporate
governance mechanism that helps ensure that managers work to maximize
shareholder wealth. Explain.

Question 39

What is meant by management's fiduciary responsibility to the firm's shareholders?
Does this mean that a firm's shareholders can sue management for bad business
decisions?

Question 40

When a manager ignores her fiduciary responsibility to her firm's shareholders,

A)she is acting unethically and illegally.
B)she is acting illegally, but not unethically or immorally.
C)she is acting unethically, but not illegally.
D)she is acting both unethically and immorally, but not illegally.

Question 41

Which of the following statements about proxy contests is true?

A)They tend to be far more successful than hostile takeover attempts.
B)They are fairly expensive and have a low probability of success.
C)They are typically used in conjunction with "friendly" takeovers.
D)Although they are almost costless to execute, they are rarely effective.

Question 42

The corporate scandals (e.g., Enron)of 2001-2003 were largely due to

A)a lack of corporate governance laws.
B)a lack of specificity in accounting standards.
C)criminal activity.
D)all of the above.

Question 43

In what three situations does the corporate board serve as an effective control
mechanism?

Question 44

Which of the following statements about corporate governance is true?

A)There is a greater need for government regulation in the case of young, upstart companies than there is for mature, well-established firms.
B)The corporate charter is the most effective control mechanism because management is bound by it.
C)A nation's economic competitiveness is dependent on good corporate governance.
D)Society can rely on the free market to ensure that firms have strong corporate control mechanisms in place; government regulation is unnecessary.

Question 45

Distinguish between inside directors and outside directors.

Question 46

In many European and Asian countries,

A)large shareholders have a legal fiduciary responsibility to the small shareholders.
B)large shareholders usually always act on behalf of the smaller shareholders.
C)large shareholders often expropriate value from smaller shareholders through tunneling.
D)Both A and C.

Question 47

Hostile takeover activity was greatest in the

A)early 2000s.
B)1960s.
C)1990s.
D)1980s.

Question 48

Which of the following is a reason that leveraged buyouts experienced a renaissance in the mid-2000s?

A)poison pill defenses
B)low interest rates
C)fewer agency excesses
D)an increase in market valuations

Question 49

In the opinion of the author of this textbook (and others), the most effective corporate control mechanism in the U.S. is the existence of

A)external threats to management.
B)legal constraints.
C)a corporation's board of directors.
D)informal social constraints.

Question 50

When management repurchases the shares of a large investor that may be threatening them at a premium price, it is called

A)greenmail.
B)a golden parachute.
C)blackmail.
D)a management buy-out.

Question 51

The Sarbanes-Oxley Act of 2002,

A)reduced the costs of corporate governance overall.
B)made improvements to some of the existing regulations.
C)was obsolete before it was ever passed.
D)focused only on accounting standards while ignoring other corporate governance issues.

Question 52

Which of the following statements about shareholder proposals is true?

A)They are fairly expensive and have a low probability of success.
B)They can only be submitted by large, institutional investors.
C)They are the most effective of the available management control mechanisms.
D)Although relatively cheap, management can ignore the a proposal, even if it is passed by a majority of the votes.

Question 53

What are some useful non-control functions performed by the corporate board
members?

Question 54

Ex-post, the Sarbanes-Oxley Act of 2002,

A)has proven to be a very cheap and effective method of corporate governance.
B)has placed a disproportionate financial burden on smaller, publicly traded corporations.
C)increased corporate costs significantly and was only modestly effective.
D)Both B and C are true statements.

Question 55

What is the typical premium paid by an acquirer in a takeover attempt?

A)15%-20%
B)35%-50%
C)20%-30%
D)10%-15%

Question 56

Which of the following is not a provision instituted by the Sarbanes-Oxley Act of 2002?

A)Executive compensation committee members must be either majority-independent or fully independent.
B)Independent directors may no longer have any type of a relationship to the firm's CEO.
C)Independent directors must meet among themselves without the presence of management.
D)Attorneys are required to alert the SEC upon receiving credible evidence of a breach of fiduciary responsibility.

Question 57

Which of the following is not a method for controlling corporate management?

A)greenmail
B)shareholder resolutions
C)the threat of a hostile takeover
D)proxy contests

Question 58

Distinguish among a corporate takeover, a proxy contest, and a shareholder proposal.
How frequently is each used, and how effective is each one as a control mechanism?

Question 59

Which of the following rules governing a firm's audit committee did the Sarbanes-Oxley Act of 2002 institute?

A)At least 50% of the membership of the audit committee must consist of independent directors.
B)The selection of the company's auditors must be made by the firm's board of directors.
C)All of the members of the audit committee must have either accounting or finance degrees.
D)At least one member of the audit committee must be a financial expert, and that member must be clearly identified.

Question 60

Section 404 of the Sarbanes-Oxley Act of 2002 prescribes that

A)the positions of CEO and chairman of the board must be held by different individuals.
B)the annual report must explain the firm's internal controls and attest to their effectiveness.
C)insider trading must be disclosed a few days before a trade is executed.
D)auditors must be rotated on an regular basis.

Question 61

What is the primary focus of the Sarbanes-Oxley Act of 2002? What are the major
good points and bad points of the Act?