Chapter 1 Flash Cards
To expand her portfolio, Genji recently purchased 400 shares of common stock in the American Power Corporation, a utility firm in Georgia. The current market price of APC's common stock is $20.85 per share. Genji's total wealth from her investment in American Power Corporation is [$8,340.00/$9,591.00/$7,089.00/$5,421.00].
$8,340.00 Note: Genji's total wealth resulting from her investment of 400 shares of common stock in the American Power Corporation is $8,340.00. Remember, the total market value of a shareholder's wealth is equal to the current market value of the shareholder's investment in the issuing company's outstanding common stock, as calculated as the product of the total number of common shares outstanding and the market price of the shares. Therefore, the current value of Genji's wealth resulting from her investment in American Power Corporation is: Genji's Wealth = Number of shares that genji owns x market price of the share = 400 shares x $20.85 per share = $8,340.00
What is true regarding the goal of stakeholder management? (Choose All Correct) - Although this goal is intuitively appealing, it is extremely difficult to implement, given the difficulties in reconciling stakeholders' equally important—but sometimes mutually exclusive and competing—objectives. - It is the theoretically superior goal of financial management. - It does not involve maximizing any one constituency's objective but achieving an acceptable level of each group's objectives. - It encourages financial managers to attempt to balance the potentially conflicting objectives of all parties that have vested interests in the firm.
- Although this goal is intuitively appealing, it is extremely difficult to implement, given the difficulties in reconciling stakeholders' equally important—but sometimes mutually exclusive and competing—objectives. - It does not involve maximizing any one constituency's objective but achieving an acceptable level of each group's objectives. - It encourages financial managers to attempt to balance the potentially conflicting objectives of all parties that have vested interests in the firm. Note: The goal of stakeholder management, or corporate social responsibility, requires financial managers to recognize and attempt to satisfy the interests and concerns of the firm's customers, employees, managers, creditors, suppliers, shareholders, and community. It encourages financial managers to attempt to balance the potentially conflicting objectives of all parties that have vested interests in the firm. It does not involve maximizing any one constituency's objective but achieving an acceptable level of each group's objectives. From a practical perspective, although this goal is intuitively appealing, it is extremely difficult to implement, given the difficulties in reconciling stakeholders' equally important but mutually exclusive competing objectives.
What is true regarding the goal of profit maximization? Check all that apply. (Choose All Correct) - An important disadvantage of this goal is that it tends to force financial managers to focus on the firm's short-term, rather than long-term, performance. - An important disadvantage of this goal is that it tends to ignore change effects in the firm's risk level. - An important disadvantage of this goal is that it tends to ignore the timing and duration of the firm's expected returns. - It requires financial managers to maximize, over the long run, the per-share price of the firm's common stock.
- An important disadvantage of this goal is that it tends to force financial managers to focus on the firm's short-term, rather than long-term, performance. - An important disadvantage of this goal is that it tends to ignore change effects in the firm's risk level. - An important disadvantage of this goal is that it tends to ignore the timing and duration of the firm's expected returns. Note: The goal of profit maximization suffers from several disadvantages, including that it tends to ignore the timing and duration of the firm's expected returns, as well as the change effects in the firm's risk level. It also tends to induce some financial managers to engage in activities that can harm the firm's long-term performance.
Maximizing shareholder wealth is considered to be a superior goal to either maximizing a firm's net profits or satisfying the interests of a firm's stakeholders. Which of the following reasons are used to justify this opinion? (Choose All Correct) - It can be manipulated by postponing or eliminating necessary expenditures in order to maximize the firm's net income. - It ignores the effect of timing changes and the riskiness of the firm's expected future cash flows on the value of the firm's common stock. - It explicitly considers the timing and the risk of the dividends and potential capital gains expected to be received by the firm's shareholders. - It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareholder wealth.
- It explicitly considers the timing and the risk of the dividends and potential capital gains expected to be received by the firm's shareholders. - It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareholder wealth. "As a goal of financial management, maximizing shareholder wealth is considered to be superior to either maximizing net profits or satisfying the interests of the firm's stakeholders for the following reasons: 1. There is only one definition and metric used to measure the effect of a particular activity on the firm's shareholder wealth: the market value of the firm's common stock. 2. It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareholder wealth. 3. The metric used to determine whether the goal is being achieved is impersonal and objective. 4. The focus on a firm's share price explicitly considers the timing and the risk of the dividends and potential capital gains that the firm expects to receive; assuming a satisfactory level of pricing transparency, a firm's share price is less likely to be manipulated by the firm's managers than the firm's profits. Attempting to simultaneously satisfy the sometimes competing desires of the firm's stakeholders (customers, employees, managers, creditors, suppliers, shareholders, and community) can be extremely difficult."
Which of the following statements regarding the goal of profit maximization are true? (Choose All Correct) - It considers both the timing and the riskiness of the business's activities. - It is popular goal because the fundamental objective of most business organizations is to make a profit, and profits are a major source that funds a firm's activities. - It results in the maximization of shareholders' wealth. - Profit is the traditional metric used to gauge whether a business organization is successful.
- It is popular goal because the fundamental objective of most business organizations is to make a profit, and profits are a major source that funds a firm's activities. - Profit is the traditional metric used to gauge whether a business organization is successful. Note: Profit maximization should be an important business goal. Two reasons for this are (1) profit making is a fundamental objective of most businesses because profits serve as a major source of funds to finance business activities and to provide returns to business owners and (2) profits serve as a traditional metric to gauge a firm's success. The most appropriate financial goal for a business, however, is the maximization of shareholder wealth. Profit maximization is not a useful decision-making criterion because (1) generally accepted accounting principles (GAAPs) provide many different definitions, calculation methods, and ways of expression for the term profit, which makes it nearly impossible to compare the profits of different companies; (2) the goal of profit maximization lacks a time dimension, which makes it impossible to differentiate between long-term and short-term profits; and (3) it doesn't consider risk assessment of alternative activities and companies.
Maximizing shareholder wealth is considered to be a superior goal to either maximizing a firm's net profits or satisfying the interests of a firm's stakeholders. Which of the following reasons are used to justify this opinion? (Choose All Correct) - It provides for the use of an impersonal and objective device, a share's market price, to measure whether the goal has been met - No mechanism currently exists to best allocate the firm's cash flows and benefits across the competing demands of the firm's stakeholders. - It can be manipulated by postponing or eliminating necessary expenditures in order to maximize the firm's net income. - It explicitly considers the timing and the risk of the dividends and potential capital gains expected to be received by the firm's shareholders. - It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareho
- It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareholder wealth. - It provides for the use of an impersonal and objective device, a share's market price, to measure whether the goal has been met. - It explicitly considers the timing and the risk of the dividends and potential capital gains expected to be received by the firm's shareholders. Note: As a goal of financial management, maximizing shareholder wealth is considered to be superior to either maximizing net profits or satisfying the interests of the firm's stakeholders for the following reasons: 1. There is only one definition and metric used to measure the effect of a particular activity on the firm's shareholder wealth: the market value of the firm's common stock. 2. It is theoretically possible to determine whether a particular decision and activity will increase or decrease the firm's shareholder wealth. 3. The metric used to determine whether the goal is being achieved is impersonal and objective. 4. The focus on a firm's share price explicitly considers the timing and the risk of the dividends and potential capital gains that the firm expects to receive; assuming a satisfactory level of pricing transparency, a firm's share price is less likely to be manipulated by the firm's managers than the firm's profits. Attempting to simultaneously satisfy the sometimes competing desires of the firm's stakeholders (customers, employees, managers, creditors, suppliers, shareholders, and community) can be extremely difficult.
What is true regarding the goal of shareholder wealth maximization? (Choose All Correct) - It requires financial managers to maximize, over the long run, the per-share price of the firm's common stock. - Over the long run, it creates and measures value for the firm. - It requires financial managers to supervise the magnitude, timing, and riskiness of the firm's cash flows, to maximize the market price of the firm's common stock. - It requires financial managers to reduce the magnitude and riskiness of the firm's cash flows and delay the receipt of its cash flows.
- It requires financial managers to maximize, over the long run, the per-share price of the firm's common stock. - Over the long run, it creates and measures value for the firm. - It requires financial managers to supervise the magnitude, timing, and riskiness of the firm's cash flows, to maximize the market price of the firm's common stock. Note: This goal of shareholder wealth maximization states that management should attempt to maximize the present value of future dividends and capital gains generated by the firm's common stock. Stated differently, this goal requires managers to attempt to maximize, over the long term, the market price of the firm's common stock. Firms accomplish this goal by managing the magnitude, timing, and riskiness of their cash flows. One important advantage of this goal is that it creates and assesses value for the firm and its managers.
Profit maximization is not a useful decision-making device for the following reasons. (Choose All Correct) - Profit maximization is not a useful decision-making device for the following reasons. Check all that apply. - It lacks the capacity to evaluate differences in the riskiness of alternative decisions. - It has the capacity to reflect time's effect on alternative decisions—for example, the differences between short-term and long-term results. - It has the capacity to evaluate differences in the riskiness of alternative decisions. - It links the firm's profits to the cash flows that are paid to shareholders. - Its absence of a time dimension means that it lacks the capacity to compare and assess the differences between the firm's short-term and long-term profits.
- Its absence of a time dimension means that it lacks the capacity to compare and assess the differences between the firm's short-term and long-term profits. - It lacks the capacity to evaluate differences in the riskiness of alternative decisions. Note: The goal of profit maximization suffers from several disadvantages, including that it tends to ignore the timing and duration of the firm's expected returns, as well as the change effects in the firm's risk level. It also tends to induce some financial managers to engage in activities that can harm the firm's long-term performance. Another Note: Profit maximization should be an important business goal. Two reasons for this are (1) profit making is a fundamental objective of most businesses because profits serve as a major source of funds to finance business activities and to provide returns to business owners and (2) profits serve as a traditional metric to gauge a firm's success. The most appropriate financial goal for a business, however, is the maximization of shareholder wealth. Profit maximization is not a useful decision-making criterion because (1) generally accepted accounting principles (GAAPs) provide many different definitions, calculation methods, and ways of expression for the term profit, which makes it nearly impossible to compare the profits of different companies; (2) the goal of profit maximization lacks a time dimension, which makes it impossible to differentiate between long-term and short-term profits; and (3) it doesn't consider risk assessment of alternative activities and companies.
Businesses can be classified into the following forms: proprietorship, partnership, corporation, limited liability company (LLC), and limited liability partnership (LLP). Different forms of businesses have different characteristics. Which of the following characteristics belong to a limited liability partnership? Check all that apply. - Profits taxed only at individual level, not at business level - Only general owners, not limited owners, allowed to participate in daily management of the firm - Distinguishes between general and limited owners
- Profits taxed only at individual level, not at business level - Only general owners, not limited owners, allowed to participate in daily management of the firm - Distinguishes between general and limited owners Note: A limited liability partnership (LLP) is similar to an LLC in that it offers features of both a partnership and a corporation. Every LLP has at least one general partner and at least one limited partner. The limited partners contribute financial resources to the firm in return for limited liability for the financial obligations of the business. Limited partners are not allowed to participate in the day-to-day management of the firm. General partners, on the other hand, retain unlimited personal liability for the debts of the business and may, according to the terms of the partnership agreement, participate in daily operations. The advantage of the LLP form is that it offers the advantages of a partnership (for example, the personal taxation of the profits of the business) without the exposure of unlimited personal liability (at least to the limited partners). It is for this reason that LLPs are popular with attorneys, accountants, and architects, although they may also be used by other businesses.
Different forms of businesses have different characteristics. Which of the following characteristics belong to a proprietorship? Check all that apply. - Can easily raise large amounts of capital - Profits taxed only once, at the individual (personal) level - Has unlimited life
- Profits taxed only once, at the individual (personal) level Note: The proprietorship is one of the oldest and simplest forms of a business organization. It is a one-person-owned business entity that is not registered as a corporation or as a limited liability company. The business owner is called the proprietor. A proprietorship can be easily and inexpensively set up. It is subject to fewer government regulations and incurs lower taxes compared to corporations. However, proprietors are subject to unlimited personal liability for their business debts; thus, personal assets are not protected. Because a single individual owns the business, the life of the business is limited to the life of the owner. Due to these factors, a proprietorship may have difficulty obtaining large sums of external financing, which could limit business growth.
Bondholders often employ a variety of devices—including restrictive covenants in the company's bond indenture agreements—to protect their interests and constrain the actions of shareholders and the firm's managers. Which of the following are restrictive covenants often used to protect the firm's bond value and bondholder wealth? Check all that apply. - Provisions that prohibit borrowing funds to pay dividends - Provisions that limit issuing new debt securities - Provisions that limit the type of investments or divestments that the firm can undertake - Provisions that require issuing new debt securities whenever interest rates drop below 5%
- Provisions that prohibit borrowing funds to pay dividends - Provisions that limit issuing new debt securities - Provisions that limit the type of investments or divestments that the firm can undertake
There are four categories of real or opportunity costs incurred by shareholders designed to prevent, mitigate, or correct management-shareholder agency conflicts 1 Expenditures to minimize management's desire to act contrary to the best interests of shareholders 2 Expenditures to monitor management's activities 3 Expenditures to provide a bond against management dishonesty 4 The opportunity cost of lost profits Identify the category of the expenditure and the best device that might be used to prevent, reduce, or correct the agency conflict: (1,2,3,4) A firm's vice president uses the company's private jet to take unauthorized personal trips on the weekends A) Conduct internal audits of the aircraft log books to determine who is using the plane, when, and for what purpose B) Purchase an insurance policy that protects against unauthorized use of the company's assets C) Identify a competitor to take over the company
Category 2 & Conduct internal audits of the aircraft log books to determine who is using the plane, when, and for what purpose. Note: Agency costs are the real and opportunity costs incurred in the prevention, reduction, and correction of agency conflicts. The vice president's unauthorized use of the corporate jet would necessitate a category 2 expenditure, which involves the monitoring of management activities. This could be accomplished through the use of internal audits of the plane's log books to determine who has been using the plane, when, and for what purpose. It is extremely unlikely that insurance policies are available to protect against the unauthorized use of the company's airplane. It is also unlikely that this behavior is sufficient to cause the firm's stock price to drop to a level that would precipitate the takeover by a competitor.
Context for below: "Remember, an agency relationship can degenerate into an agency conflict when an agent acts in a manner that is not in the best interest of his or her principal. In large corporations, these conflicts most frequently involve the enrichment of the firm's executives or managers (in the form of money and perquisites or power and prestige) at the expense of the company's shareholders. This usurping and reallocation of shareholder wealth is most likely to occur when shareholders do not have sufficient information about the decisions and actions being made by the firm's management."
Context for below: "Consider the following scenario and determine whether an agency conflict exists: Alexander and Akiko equally own and manage A New Beginning (ANB), a store that sells preowned clothing and furniture. Alexander is responsible for ANB's back-office activities, and Akiko staffs the store and makes deliveries to customers. Both have equal decision-making authority and, under the terms of their partnership agreement, both are prohibited from making personal purchases using company funds without prior approval of the other partner. Alexander, without Akiko's knowledge, used the company's bank account recently to purchase a new sports car. Alexander has acknowledged that the car will not be used to support the business."
Context for below: "Five years ago, Tae created a plant-care business that grew, stocked, and maintained fresh plants in office buildings throughout Houston. Over time, The Green Zone Inc. (TGZ) has grown from a proprietorship into a corporation, now reaching far beyond Houston. To finance and support this growth, TGZ issued shares that were sold to TGZ employees, Tae's family members, and selected outsiders. Tae is TGZ's chairman of the board of directors and CEO, but he is no longer the largest shareholder."
Context for below: "At the latest annual meeting, two mutually exclusive proposals were placed on the ballot for discussion and vote. The first was put forth by Tae and TGZ's management team, and the second was proposed by a small group of other shareholders. Both groups are adamantly opposed to the other group's proposal, even though both proposals would likely have the same effect on TGZ's value and riskiness."
Most executives believe that they and their firms behave in an ethical manner and that it is in their best interests to do so. How can a firm's ethical conduct increase its long-term profitability? A) Ethical corporate behavior is always more costly, because it generally results in more constrained and expensive behaviors. B) Ethical corporate behavior reduces unnecessary legal expenses and the need to pay fines.
Ethical corporate behavior reduces unnecessary legal expenses and the need to pay fines. Note: Many executives believe that a positive correlation exists between a firm's ethical behavior and its long-run profitability as a result of its ability to reduce expenses, protect or enhance the firm's image, and attract support from the firm's stakeholders. Examples include the hiring of excellent managers and employees and attracting customers, investors, business partners, and community support. Because ethical organizations tend to have ethical leaders, they are not inclined to treat their ethics or their behavior casually or to hire potentially unethical colleagues. Good corporate ethics programs are developed from the top down, with the firm's leadership modeling good ethical behavior and explicitly expecting it from subordinates. For ethics programs to be effective, leaders must do more than encourage ethical conduct; they must actively and openly display ethical conduct and expect the same from all colleagues, subordinates, and business partners.
Explanation for above: Agency conflicts between shareholders and bondholders are the result of differences in their concerns and motives, as well as differences in the variability of the return that their securities generate. Both groups are concerned with earning and retaining wealth; bonds pay a fixed return on the investment, but common shares offer a return that can fluctuate with the riskiness of the firm and its cash flows. The shareholder-bondholder agency conflict arises because changes in the firm's risk have opposing effects on the value of bonds and shares. In general, increases in the firm's risk: 1. increase the return earned by the firm's shareholders, 2. increase the market value of the firm's common shares, 3. have no effect on the return earned by the firm's bondholders, and 4. decrease the value of the firm's bonds."
Explanation for above: "Decreases in the firm's risk have the opposite effect. It is therefore little wonder that bondholders are concerned with the riskiness of the activities undertaken by the firm and why—unless such activities are constrained somewhat—these bondholders might have a conflict with the firm's shareholders. Among the devices used to protect bondholder interests and constrain the actions of the firm's managers are restrictive covenants that: 1. limit dividends paid to stockholders, 2. prohibit borrowing funds to pay dividends, 3. limit issuing new debt securities, and 4. limit the type of investments or divestments that the firm can undertake. When bondholders are exposed to risks that cannot be offset using these and other restrictive covenants, they may require a higher interest rate or return on their bonds."
Suppose a new law made it more difficult to stage a hostile takeover. Which of the following groups would benefit the most? (Choose One) - Management - Activist investors - Bondholders
Management Note: Any legislation that makes hostile takeovers harder to stage (and thus less of a risk to management) will increase the potential for an agency conflict. The firm's management will benefit from the new law that will make it more difficult to conduct hostile takeovers. If managers know hostile takeovers are less likely, they will not feel such strong pressure to please shareholders.
Question: The most theoretically sound goal of financial management should be: (Choose One) - Maximizing the firm's shareholder wealth - Maximizing the firm's management wealth - Maximizing the firm's bondholder wealth - Maximizing the firm's profits
Maximizing the firm's shareholder wealth Note: The theoretically superior goal of financial management is to maximize the wealth of the firm's common shareholders, as measured by the market price of the firm's common stock. Among the theoretical advantages of the goal of shareholder wealth maximization are: 1. it explicitly considers the timing and risks of the expected benefits associated with stock ownership. 2. it is conceptually possible to ascertain if a specific financial decision is consistent with this goal by examining the effect of the decision on the market price of firm's common shares. 3. it is an impersonal and non-subjective objective, and allows dissatisfied shareholders to sell their shares and invest the proceeds in a firm that is more consistent with their preferences.
Does an agency conflict exist between TGZ's management and the small group of opposing shareholders? (Choose One) - No; Tae was the original owner of TGZ, so he would always be sensitive to the concerns of the firm's current owners (shareholders) and would not engage in an agency conflict. - No; although an agency relationship exists between TGZ's management—including Tae as TGZ's chairman and CEO and the firm's shareholders—there is no agency conflict, because no expropriation or wasting of the shareholders' wealth has occurred. - Yes; an agency relationship exists, and an agency relationship always gives rise to agency conflicts, regardless of the actual behavior of the participants. - Yes; any conflict or disagreement between the firm's managers and its shareholders constitutes an agency conflict.
No; although an agency relationship exists between TGZ's management—including Tae as TGZ's chairman and CEO and the firm's shareholders—there is no agency conflict, because no expropriation or wasting of the shareholders' wealth has occurred. Note: In this case, there is an agency relationship, but there is no agency conflict. Although the firm's management team and some of its shareholders disagree, there is no informational imbalance or expropriation of shareholder wealth. Tae and TGZ's management team are not taking action (or failing to take action) in order to benefit themselves (for example, to enrich themselves, protect their jobs, or enhance their power or reputations). Be aware that agency conflicts are different from mere differences of opinion. Differences of opinion that do not involve informational imbalances or enrichment of the agent at the expense of the owner should not be considered agency conflicts.
Which of the following actions will help ease agency conflicts and better align managers' objectives with the firm's shareholder wealth? (Choose One) - Pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth. - Pay the manager a large base salary with a huge stock option package that matures on a single date.
Pay the manager a combination of salary and stock options (phased in over several years) that reward him or her for consistently increasing shareholder wealth. Note: Compensation packages can be used to align the objectives of the company's managers with the long-term wealth goals of its shareholders. A compensation package that includes only a salary and no stock options will not motivate the executive to increase the stock price. A good compensation package must include at least one feature that strongly links the wealth of the executive to the wealth of the firm's shareholders. A stock option plan that matures only on one specific date will motivate an executive to maximize the stock price on that date, but it won't strongly motivate the executive to maximize the price the rest of the time. In contrast, a compensation plan that includes a salary plus stock options that vest in phases over a period of time rewards the executive for consistently maximizing shareholder wealth.
The actual goals pursued by the firm's financial managers may not attempt to maximize the firm's shareholder wealth because: (Choose One) - The firm's managers and shareholders have different motives and desires - The firm's managers fear bondholders and other creditors more than they fear shareholders. - The firm's managers would rather focus on the firm's short-term, rather than its long-term, performance. - The firm's managers consider the goal of maximizing shareholder wealth to be discriminatory against the concerns and objectives of other stakeholders.
The firm's managers and shareholders have different motives and desires Note: The actual goals pursued by the firm's financial managers may not be consistent with the goal of maximizing shareholder wealth because the firm's managers and its shareholders may have different motives, concerns, and desires. For example, shareholders are often concerned with making as much money as they can on their investments, either in the form of dividend income or an appreciation in the market value of their shares. Managers, on the other hand, are often concerned with: 1. Maximizing their power, which may result in them undertaking activities that produce more risk than will maximize their shareholders' wealth. 2. Retaining their jobs, which may result in them recommending and undertaking activities that are less risky than those that would otherwise maximize their shareholders' wealth. 3. Consuming an excessive quantity of perquisites ("perks"), which may result in expenses that reduce their shareholders' wealth. This inconsistency is what gives rise to agency conflicts between a firm's managers and their shareholders, and necessitates the company incurring the additional costs of dealing with those conflicts. Among these costs are management-monitoring costs, the costs of structuring shareholder wealth-maximizing compensation packages, bonding expenses, and opportunity costs.
Which of the following behaviors involves ethical—as opposed to unethical—decision making? A) While interviewing prospective applicants for a manager-trainee position, the company's recruiter makes sexually suggestive remarks to the applicants and recommends hiring only the good-looking candidates. B) A firm's purchasing manager recommends that the purchase be made from his cousin's firm rather than from one of two other vendors offering identical equipment at lower prices. C) While planning for an upcoming company audit, a manager insists on hiring an external auditing firm to audit the company's financial statements. D) While riding in a taxi, a loan officer with the Fifth County Bank finds a briefcase containing confidential and proprietary lending policies of a competing bank. She keeps the competing bank's information and distributes it at the next loan application review meeting.
While planning for an upcoming company audit, a manager insists on hiring an external auditing firm to audit the company's financial statements. Note: Ethical managers and their employees will treat the company's customers with fairness and respect while also looking out for the firm. They will also (1) ensure that their personal interests do not conflict with the business decisions that they are making; (2) respect the confidentiality of information entrusted to them; and (3) make decisions on the basis of rational, objective business criteria rather than on the basis of inappropriate factors such as race, gender, or religion. The expectation that managers and employees will behave ethically means the loan officer, the company recruiter, and the purchasing manager participated in unethical behaviors.
Is this a potential agency conflict between Alexander and Akiko? (Choose One) - Yes; it should have been Akiko who purchased the car. - No; Alexander and Akiko co-own and co-manage ANB and have a partnership agreement that makes them equal, so an agency conflict cannot exist. - No; Alexander and Akiko are both authorized to spend ANB's money, so no conflict of interest can occur. - Yes; Alexander is misappropriating some of Akiko's wealth by unilaterally purchasing a nonbusiness asset using ANB's funds.
Yes; Alexander is misappropriating some of Akiko's wealth by unilaterally purchasing a nonbusiness asset using ANB's funds. Note: Alexander and Akiko have an agency conflict. Despite the partnership agreement that is intended to reduce the imbalance of information between them, it may still be possible for a partner to expropriate the wealth of the remaining partner. An agency conflict exists, because Alexander implemented a managerial action (bought a personal asset) that conflicted with Akiko's ownership interests and usurped some of her wealth.
Devin, the CEO of a juice beverage company, is required to file the company's quarterly and annual employment, financial, and tax reports with the state and federal authorities. This is an example of: an LLP/LLC. A) a corporation. B) a proprietorship. C) a partnership.
a corporation Note: Devin's beverage company is an example of a corporation. Corporations are required to release quarterly and annual information on the company's performance, employment, finances, and taxes to state and federal authorities. According to the Sarbanes-Oxley Act of 2002, both the chief executive officer (CEO) and the chief financial officer (CFO) are required to certify the accuracy of the information contained in the firm's financial statements, reports, press releases, and any other public announcement.
Hard Rock Mining is a mineral mining company. The CEO of Hard Rock Mining died last month. The news led to a short-term decline in the company's stock price, but the price bounced back after the company announced its increased quarterly earnings. This is an example of: A) a partnership. B) an LLP/LLC. C) a proprietorship. D) a corporation.
a corporation. Note: A corporation is a legal entity that is created to separate the ownership of the firm from its management and operation. In this case, the CEO's death had an impact on the company's short-term condition. However, corporations are run by a board of directors and the firm's management team. This allows the operation of the firm to continue beyond the life of the CEO.
Esteban founded and operated a lunch-only catering business, which specialized in providing fresh, delectable, eat-at-your-desk lunches to office workers. When he died, the business was dissolved because there was no plan for succession (control) in the event of his death. This is an example of: A) an LLP/LLC. B) a partnership. C) a proprietorship. D) a corporation.
a proprietorship Note: Esteban's catering business is an example of a proprietorship. The life of the business was limited to the life of the proprietor.
Left unaddressed, these conflicts can produce significant real and opportunity costs that the firm's shareholders and other stakeholders must bear. Examples of management behaviors that are not in the best interests of the firm's shareholders include shirking, an excessive consumption of perquisites, an excessive concern with job security, reduced or excessive risk taking, and/or undertaking activities that are principally intended to expand or enhance a manager's ego, prestige, or power. To prevent, reduce, or correct these conflicts between their managers and themselves, shareholders often have to incur additional real costs called [agency/conflict resolution] costs.
agency
You see and read about different kinds of businesses every day. Use the description of each business to classify it as a proprietorship, partnership, corporation, or limited liability partnership and/or limited liability company (LLP/LLC). Paradigm Media is a company run by a group of new media professionals. The owners of the company do not have any personal liability and file taxes only on their individual tax returns. This is an example of: A) a corporation. B) an LLP/LLC. C) a partnership. D) a proprietorship.
an LLP/LLC. Note: Paradigm Media is an example of a limited liability company (LLC). The LLC combines the benefits of a partnership and a corporation. An LLC protects the owners from personal liability. Profits, losses, deductions, and credits are passed to the members of the firm, and each pays taxes only at the individual level.
Agency conflicts are a special example of a conflict of interest; specifically, they are created by the relationship between [an employee and a supervisor/an agent and a principal], and result from inconsistencies or disputes between the interests and motivations of the different parties. The magnitude of these conflicts may be made larger or smaller by the environment in which they occur and the availability of techniques or events to prevent, reduce, or rectify them.
an agent and a principal Note: The modern business organization offers the potential for many conflicts of interest. Agency conflicts, however, are a special case of a conflict between two parties with opposing interests and motives. The conflict between one or more principals and their agent is called an agency conflict. In a corporation, principals, in the form of the firm's common shareholders, employ one or more agents—the firm's board of directors and, by extension, the chief executive officer and other C-suite officers (such as chief operating officer, chief financial officer, chief risk management officer, chief information officer, and so on)—to manage the company on their behalf. The separation of ownership and management and the delegation of decision making by the owners to their professional managers create opportunities for agency conflicts between those managers and their shareholders.
While the agency conflicts between managers and shareholders tend to receive the most press, they are not the only agency conflict affecting the modern corporation. Another equally important agency conflict is sometimes observed between a firm's common shareholders and its bondholders. As before, the basis of this conflict is divergent concerns and motives. In general, bondholders purchase corporate securities that provide a [fixed/variable] return, whereas shareholders purchase shares that are likely to provide a return that fluctuates with the riskiness of the firm.
fixed
In addition, potential bondholders may require a [lower/higher] interest rate on the firm's soon-to-be-issued bond as compensation for the risks that cannot be adequately protected against using the restrictive covenants.
higher
Two years have passed since Genji purchased her 400 common shares in the American Power Corporation. The market price of the company's shares is now $22.94 per share. As a result, Genji's wealth from her investment in APC has [increased/decreased/not changed] by [$585.20/$836.00/$1,463.00/$961.40], assuming that everything else remains constant.
increased, $836.00 Note: The goal of shareholder wealth maximization implies that managers should make decisions that maximize the long-run value of the company's stock. It is generally acknowledged that if the value of the firm's stock increases over the long run, then the managers are making good decisions that are consistent with maximizing the shareholders' wealth. If the price of the firm's common shares decreases over the long run, however, then it is generally concluded that the managers are not making decisions that will maximize the wealth of their owners. During the past two years, the market value of Genji's 400 shares in APC has increased from $20.85 per share to $22.94. From this, it can be concluded that Genji's wealth has also increased by $836.00 [($22.94 - $20.85) per share x 400 shares], assuming that everything else remains the same.
If managers undertake projects that decrease the riskiness of the firm and its cash flows, then the wealth of the firm's bondholders will be [increased/decreased], while that of the firm's shareholders will be [decreased/increased].
increased, decreased
According to finance theory, firms should attempt to [maximize/minimize] the long-term price of the firm's [common stock/long-term stock]. The benefit to this objective is that it provides the best financial outcome for the firm's shareholders.
maximize, common stock Note: According to finance theory, a business firm should attempt to maximize the long-term price of the firm's common stock. The benefit to this objective is that it provides the best financial outcome for the firm's shareholders, who are the owners of the corporation.
For example, in businesses managed by professional managers, managers frequently have less financial and emotional commitment to the business than the firm's owners (the firm's common shareholders). The [merging/separation] of ownership and management and the [usurping/delegation] of decision making by the owners to the professional managers create an environment in which these conflicts can take root.
separation Note: When corporations are closely held or the owners are concentrated and motivated to actively oversee management activities, agency conflicts are less likely to occur. However, when a corporation's ownership is either geographically dispersed and located some distance from the corporation or when there are many shareholders holding relatively small stakes in the firm, opportunities for agency conflicts increase. These circumstances give managers greater opportunities to attempt to maximize their personal welfare (utility) at the expense of the wealth and welfare of the firm's shareholders. Examples of management behaviors that are not in the best interests of the firm's shareholders include shirking, an excessive consumption of perquisites, an excessive concern with job security, reduced and excessive risk taking, and undertaking activities that are principally intended to expand or enhance a manager's ego, prestige, or power. Agency conflicts and their prevention, reduction, and correction are critical to the firm's shareholders, because monies that would otherwise be paid to or reinvested on behalf of the shareholders are spent paying agency costs. These agency costs may be satisfied either with the payment of actual cash funds or by incurring noncash opportunity costs.
