Question 1

Suppose in order to defraud the shareholders,a manager sets up an independent company that he owns and buys one of the main company's inputs of production from this company.He would be tempted to set the transfer price

Accepted Answer

By setting the transfer price above the market price, the manager can generate a profit for his independent company and decrease the profitability of the main company, thereby defrauding the shareholders. Setting the transfer price below the market price would not benefit the manager's independent company, and setting it at the market price would not achieve the desired outcome of defrauding the shareholders. As for GAAP, setting the transfer price in accordance with GAAP may not necessarily prevent fraudulent activities.

Question 2

The agency problem refers to the possible conflicts of interest between

Accepted Answer

The agency problem arises due to the conflict of interest between self-interested managers who act as agents and shareholders of the firm who act as principals. These managers may prioritize their self-interest over the shareholders' interest, leading to actions that may not be in the best interest of the firm or its stakeholders. The principal-agent relationship can be improved by aligning the interests of the agents with those of the principals, and implementing effective monitoring and incentive mechanisms.

Question 3

It is important for society as a whole to solve the agency problem,since the agency problem

Accepted Answer

The agency problem leads to all of the mentioned consequences, including the waste of scarce resources, the hampering of capital market functions, and the retardation of economic growth. Therefore, it is important for society as a whole to solve this problem.

Question 4

In high-growth industries where companies' internally generated funds fall short of profitable investment opportunities,

Accepted Answer

In high-growth industries, companies often have more profitable investment opportunities than they can fund with their internally generated funds. This can lead to managers being more likely to waste funds in unprofitable projects, as they are under pressure to find ways to use the company's excess cash.

Question 5

In the U.S.,the chief role of the board of directors is

Accepted Answer

The chief role of the board of directors is to hire the management team. This includes appointing and supervising the executive team, setting the overall strategy and direction of the company, and monitoring its performance to ensure that it is meeting its objectives and fulfilling its responsibilities to stakeholders. While the board may also be involved in other aspects of corporate governance, such as deciding on the annual budget or designing compensation schemes, its primary function is to oversee the management of the company.

Question 6

Tobin's Q is

Accepted Answer

Tobin's Q is defined as the ratio of the market value of a company's assets to the replacement costs of those assets.

Question 7

Self-interested managers may be tempted to

Accepted Answer

Self-interested managers may be tempted to indulge in expensive perquisites, adopt anti-takeover measures, waste company funds on their personal projects, or any combination of these actions, all of which can be detrimental to shareholders' value. Therefore, all of the options mentioned in the question are potential abuses that self-interested managers may be tempted to visit upon shareholders.

Question 8

Managerial entrenchment efforts are clear signs of the agency problem.They include

Accepted Answer

Managerial entrenchment efforts include all of these options, making it more difficult for a firm to be taken over and allowing managers to maintain power and control even in the face of poor performance or shareholder dissatisfaction. These efforts can exacerbate the agency problem, as managers may act in their own interests rather than in the best interests of shareholders.

Question 9

Why is it rational to make shareholders "weak" by giving control to the managers of the firm?

Accepted Answer

All of the options are valid reasons for why it may be rational to separate ownership and control and give more power to managers of a firm. Shareholders may not be qualified or interested in making business decisions, they may find it easier to sell their shares than monitor management, and ultimately managers are answerable to the board of directors.

Question 10

The investors supply funds to the company but are not involved in the company's daily decision making.As a result,many public companies come to have

Accepted Answer

When investors supply funds but do not involve themselves in daily decision-making, it typically results in a scenario where the management has more control over the company's operations, leading to strong managers and weak shareholders. This is because the shareholders' lack of involvement in daily decisions diminishes their influence over the company's strategic direction.

Question 11

In the graph,X,Y,and Z represent

Accepted Answer

The graph shows two instances of alignment (where X and Z are both high) with entrenchment (when Y is high) in between. There is no evidence of misalignment, agency costs of debt, or agency costs of equity in the graph.

Question 12

Why do managers tend to retain free cash flow?

Accepted Answer

Managers may retain free cash flow for reasons that do not align with shareholders' best interests, such as empire building or personal incentives, rather than distributing it to shareholders.

Question 13

A complete contract between shareholders and managers

Accepted Answer

A complete contract between shareholders and managers would indeed specify managerial actions for all possible future contingencies, be costly to write and monitor, and aim to eliminate conflicts of interest and managerial discretion, encompassing all the options listed.

Question 14

In the United Kingdom,the majority of public companies

Accepted Answer

In the United Kingdom, public companies are not compelled by law to abide by the Code of Best Practice on corporate governance. However, the majority of them voluntarily choose to abide by the code in order to enhance the transparency, accountability, and ethical practices within their organization.

Question 15

Morck,Shleifer,and Vishny (1988)studied the relationship between managerial ownership share and firm value for Fortune 500 U.S.companies.The results of their analysis suggested that the first turning point (the first vertical,dashed line between X and Y)is reached at ________ percent and the second turning point (the second vertical,dashed line between Y and Z)at about ________ percent,respectively.

Accepted Answer

The answer of Morck,Shleifer,and Vishny (1988)studied the relationship between managerial...

Question 16

Free cash flow refers to

Accepted Answer

Free cash flow refers to the cash a company has left over after it has paid for all of its capital expenditures, including investments in property, plant, and equipment, and working capital. It is the cash that a company has available for new investments, dividends, and share repurchases. It represents the amount of cash generated by a company's operations that is available for expansion, paying down debt, or distributing to shareholders. Option A and C don't consider capital expenses, and option D doesn't relate to the definition of free cash flow.

Question 17

Suppose in order to defraud the shareholders,a manager sets up an independent company that he owns and sells the main company's output to this company.He would be tempted to set the transfer price

Accepted Answer

Setting the transfer price below market prices allows the manager to buy the main company's output at a lower cost through the independent company he owns, thereby defrauding the shareholders by diverting profits from the main company to his own.

Question 18

Outside the United States and the United Kingdom,

Accepted Answer

In many countries outside the United States and the United Kingdom, companies often have a more concentrated ownership structure, making diffused ownership (where shares are spread out among a large number of shareholders) more the exception than the rule. This is due to various factors, including family ownership, state ownership, and the presence of large individual or corporate stakeholders.

Question 19

The agency problem tends

Accepted Answer

The agency problem tends to be more serious in firms with free cash flows and excessive amounts of excess cash because managers may pursue their own interests rather than those of shareholders. It can also be less serious in firms with fewer shareholders due to closer monitoring.

Question 20

Which of the following is true regarding leveraged buy-outs (LBOs)?

Accepted Answer

LBOs involve managers or buyout partners acquiring controlling interests in public companies (usually financed by heavy borrowing), and concentrated ownership and high levels of debt associated with LBOs are the mechanism for solving the agency problem. This option accurately describes the nature of LBOs and their mechanism for solving the agency problem. Option A is partially correct, but it does not mention the relevance of concentrated ownership and high levels of debt. Option B is incorrect because high levels of debt may exacerbate the agency problem. Option C is also incorrect because LBOs typically increase a company's debt levels, and it may not necessarily improve free cash flow or solve the agency problem.

Quiz 4: Corporate Governance Around the World