Chapter 12

63) Sorenson LLC, a publicly traded company, has ten members on its board. Of the ten members, six members are employees of the company—including the CEO, who also chairs the board. The board has been failing in its responsibilities toward the shareholders, who now want a new board. Assuming that the total number of board members remains constant, how many outside directors should the shareholders appoint to Sorenson's board to achieve board independence?

7

14) Which of the following descriptions best exemplifies adverse selection?

A manager cannot ascertain the contributions of individual team members in team production.

49) Adverse selection in a public stock company occurs when

A) information asymmetry increases the likelihood of selecting inferior alternatives.

39) Which of the following real-world scenarios best exemplifies information asymmetry in a public stock company?

Based on a tip-off by a Goldman Sachs employee, the Galleon Group sold its holdings in Goldman Sachs' stocks prior to the announcement of missed earnings estimates.

60) Bellhaven Inc. has a board of directors that consists of seven members. Which of the following is most likely an accurate statement about Bellhaven's board of directors?

Bellhaven's board of directors has a minority number of inside directors and it evaluates the firm's strategic initiatives.

17) Eyenima Inc. is a public stock company. Which of the following best exemplifies the legal personality of the company?

Bjorn Eyenima, the company's founder, died a few years ago, yet the company is doing well.

23) Arnold is a firm believer in Milton Friedman's view of a firm's social obligations. With which of the following statements is Arnold most likely to agree?

Businesses can use their resources to create profit as long as they do so within the rules of the game.

45) Stella accepts a job as vice president for human resources at a technology startup. She discovers that the startup believes that teamwork is so important that it plans to award all raises and bonuses by splitting them equally within a team rather than presenting them to individual employees. What action should Stella take regarding this plan?

Cancel the plan because under it, opportunistic employees will do little or no work.

72) Which of the following is true of business ethics?

Certain notions such as fairness, honesty, and reciprocity are universal norms.

36) Sirhan is president of a medium-sized bank. What can he do to lessen the chances of employees or board members taking part in insider trading?

Create a strict code of ethics and explain that inside traders will be fired.

28) Why does Michael Porter recommend expanding the customer base of an organization in terms of the shared value creation framework?

Doing so could yield significant business opportunities that could improve the standard of living of the poor.

82) Which of the following is an implication for the strategist in the context of corporate governance and a company's success?

Effective corporate governance and solid business ethics are critical to gaining and sustaining competitive advantage.

26) Which of the following perspectives best supports the shared value creation framework?

Externalities such as pollution, wasted energy, and costly accidents actually create internal costs.

10) Research indicates that most corporate ethics problems are caused by a few "bad apples" rather than an unethical culture.

FALSE

2) A detergent manufacturer decides to clean up the waterways it uses even though no federal, state, or local laws require the firm to do this. The firm's managers believe that the cleanup will improve the company's image and benefit the environment. This scenario is an example of shareholder capitalism.

FALSE

4) Jeannette was a manager at Fabco. Instead of working full-time on Fabco's projects, she used Fabco's tools, employees, computers, and other resources to work on a research project that she hopes might help her start her own firm. This is an example of adverse selection.

FALSE

5) One of the most challenging aspects of principal—agent problems is that firms have almost no defenses against them.

FALSE

7) It is up to shareholders to make certain that the financial statements that their firms release are correct and not misleading.

FALSE

8) It can be difficult for shareholders of publicly traded companies to determine how much money those companies are making or losing because these companies use different accounting firms, and each accounting firm follows different rules.

FALSE

50) Gino is the CEO of a financial services firm. What action should Gino take to be sure the firm avoids moral hazards?

Gino should define undue risk-taking, institute strict auditing of loans, and make it clear that the company will fire employees who lend recklessly.

52) Andrew is the president of a technology firm that has recently gone public. What action, if any, should Andrew take to build the confidence of his new shareholders?

He should find out whether the majority of his shareholders want long-term steady growth or short-term spikes in the stock price.

83) Elvira is the CEO of a firm. She has an opportunity to increase the competitive advantage of her company but is not sure if accepting the opportunity is ethical. Which of the following questions would help her decide if accepting the opportunity is ethical?

How would the media report her decision to accept the opportunity if it were to become public?

77) Which of the following best supports the fact that Goldman Sachs was unethical in the Abacus deal?

It knew that Paulson & Co. had bundled high-risk mortgages into the collateralized debt obligation.

22) What is the result of managers' pursuit of strategies that define value creation too narrowly in public stock companies?

It reduces the trust of shareholders in the organization as a vehicle for value creation.

65) GameGo is a publicly traded manufacturer of home electronics. Based on what you have read, which of these actions would be wisest for GameGo's board of directors to take to be sure that the company's new CEO is as motivated as possible?

Link the CEO's pay to her performance, but avoid high-powered incentives that may cause reckless behavior.

78) Sanjaya was recently hired at an up-and-coming firm that has a history of ethics violations. Which action is best for him to take if he wants to determine whether the firm is now acting ethically?

Observe executives at the company, and see whether they model ethical behavior and demand it of others.

54) Delores recently became a board member of a firm that has a history of reckless actions by senior employees. Which task would be appropriate for Delores to undertake to help safeguard the company's financial health?

Request and review a copy of the firm's risk assessment plan, if such a plan exists.

40) Barrett is the ethics officer at Exton Corp., a publicly traded company. She wants to make sure that on-the-job consumption at Exton stays within legal and ethical bounds. Which action should she and the Exton board of directors take?

Set strict limits on what executives can spend on office redecoration or work-related celebrations.

15) Ignacio Inc. is a public stock company. Which of the following statements about the company best illustrates the fact that its investors have limited liability?

Shareholders of Ignacio are responsible to the company only to the capital they have invested.

12) Angie owns and runs Archana, a private start-up company with a current value of $1.3 billion. Archana is interested in going public to fund future growth. Which action should Angie take before Archana's initial public offering?

She should investigate Archana's existing or potential problems with ethics or the law, if such problems exist.

1) If a privately held company has a history of legal and ethical problems, those problems can prevent a successful initial public offering (IPO) from taking place.

TRUE

3) Dinesh is a senior manager at a large, publicly traded corporation. He has access to insider information about the company profits, losses, mergers, and acquisitions. It is legally and ethically acceptable for him to have this information as long as he does not use it to buy or sell stocks and does not tell others to buy or sell stocks.

TRUE

6) Linda owns and runs her own firm. She also serves on the boards of several companies. Although she does not work for these companies, she attends board meetings, analyzes information, and tries to act in the best interests of their shareholders. Linda is an example of an outside director.

TRUE

9) Corporate codes of conduct go beyond what the law requires, imposing higher standards of honesty and fairness.

TRUE

64) General Electric's board has only one inside director, John Flannery, GE's CEO, who also acts as chairman of the board. This is known as duality. Which of the following statements represents the best argument for this duality in GE?

The CEO possesses invaluable inside information that can help him or her chair the board effectively.

27) Which of the following statements best supports the view that GE's Ecomagination strategy is in line with the shared value creation framework?

The Ecomagination strategy allows GE to produce "green" products while increasing revenue and competitive advantage.

75) A bank, CQC, offers a customer a personal loan. In which of the following circumstances will this decision most likely be considered unethical?

The bank knows that the customer will be unable to pay the loan if the interest rate rises.

67) Which of the following is a common result of a hostile takeover of a company?

The new owner sells the company in pieces.

73) What helps notions such as fairness, honesty, and reciprocity to be codified into law?

The notions are universal norms.

70) Which of the following scenarios best exemplifies a leveraged buyout of a microchip manufacturer, Rigoletto Inc.?

The owner of another company buys all the outstanding shares of Rigoletto in order to take it private.

71) What are poison pills?

They are defensive provisions that kick in should a buyer reach a certain level of share ownership.

13) Which of the following statements is true of shareholders in a public stock company?

They are granted a charter of incorporation by the state and legally own company stock.

76) Which of the following is true of the codes of conduct of an organization?

They detail how the organization expects an employee to behave and to represent the company in business dealings.

20) According to Michael Porter, which of the following is a problem with many publicly traded companies?

They have defined value creation too narrowly in terms of financial performance.

79) Three months ago, Darren became a board member at Runswell, a publicly traded company. Two weeks ago, the board members discovered that Runswell's CEO is facing a lawsuit from a family member who accuses the CEO of theft. Based on what you have read, to what ethical standard should Darren and the other board members hold the CEO?

They must hold her to the highest ethical standards because the leaders of publicly traded companies must withstand intense public scrutiny.

11) How did Uber conflict with Carnegie Mellon University's National Robotics Engineering Center (NREC)?

Uber poached entire NREC research teams with signing bonuses, twice the salaries, and stock options, thereby threatening the future of NREC.

53) Which of the following is true of the board of directors in a public stock company?

Votes at shareholder meetings determine whose representatives are appointed to the board of directors.

38) Ben is a manager at Unique Accessories Inc. and is friends with the company's CEO. This privilege gives Ben the information that Unique Accessories is in the midst of talks to take over a leading rival. Ben buys stocks of Unique Accessories with the expectation that its stocks will appreciate. But the deal falls through, and the stocks of Unique Accessories depreciate in the following months. Are Ben's actions unethical? Why or why not?

Yes. It is unethical to trade stocks based on insider information, irrespective of the final outcome.

46) Nate is a recent graduate who states that he has interned at a major accounting firm so that his value as a candidate for employment increases. A start-up recruits Nate based on his stated credentials without verifying them. Two days into the job, Nate's team lead realizes that Nate does not know much of what he claimed to know during the interview. This scenario best exemplifies

adverse selection.

48) At Agile Ltd., a cross-functional team is formed to work on a project for a new client. The team consists of Charles and four other members. At most of the team's presentations to senior management, Charles takes the lead and discusses project specifics with the management, while others chip in with additional information. At the completion of the project, Charles is recommended for promotion, while the other team members receive little recognition for their hard work. The reality is that Charles did very little actual work but spent some time compiling the project report based on different documents submitted by the others. This scenario at Agile Ltd. is a typical consequence of

adverse selection.

85) The name for an agreed-upon code of conduct in business, based on societal norms, is

business ethics.

44) David and Fred are customer care employees at JPN Care. In between calls, David and Fred spend time on Facebook and YouTube. The relaxed guidelines at JPN allow them to do that. However, sometimes, they knowingly avoid answering calls or keep customers on hold, while they check their social networking accounts. Such behavior

can be stopped by implementing performance incentives and strict control mechanisms.

41) According to the agency theory,

conflicts that arise in corporations should be addressed in the legal realm.

68) Because of poor management, the stock price of Orange Dolphin Inc. falls and many investors sell their shares. Soon Orange Dolphin becomes the target of a hostile takeover, during which Hans buys enough shares to exert control over the firm. In this scenario, Hans performs the role of a(n)

corporate raider.

80) One way to foster ethical behavior in employees is to

create a control system that encourages desired values.

19) Starling Inc. is a public stock company that provides natural gas for businesses. Although this company generates a large profit, management's focus on reducing costs caused the maintenance budget to be trimmed. Its pipelines have at times leaked, which created significant environmental problems. As a result, the company's value creation has suffered. This scenario supports Michael Porter's warning that public companies

have defined value creation too narrowly in terms of financial performance, thereby contributing to black swan events.

24) According to the perspective of shareholder capitalism, shareholders in public stock companies

have the most legitimate claim on profits.

58) The board of directors of a public stock company consists of

individuals who formally represent the firm's shareholders and oversee the work of executives.

34) Marika received a tip from a close friend who is an executive manager of a publicly traded company called MicroGreen Inc. The manager received some inside information about how to trade MicroGreen stock to get a huge profit. He shared this information with Marika. This scenario is an example of

information asymmetry.

43) The root cause of the principal-agent problem between senior executives and lower-level employees can be explained by the

informational advantage of the lower-level employees.

57) Landon is a senior manager for the firm Anderssen Inc. Because of his experience, he has been appointed to the board of EEC Inc., even though he doesn't work for this firm. He also serves on the boards of several other companies. Landon is a(n) ________ for Anderssen and a(n) ________ for EEC.

inside director; outside director

59) What do we call the board members who are part of a company's senior management team appointed by shareholders to provide the board with necessary information pertaining to the company's internal workings and performance?

inside directors

37) The informational advantage that agents possess over principals is often based on the fact that

insiders are the first to learn about important developments before the information is released to the public.

61) Bernard is a board member at Lopez Electronics Inc. He is also a senior executive of the firm. The board is chaired by Ernest Jones, the CEO of Stanley Motors. According to this scenario, Bernard

is an inside director of Lopez Electronics.

84) A mortgage-loan officer persuades unsuspecting consumers to sign up for exotic mortgages, such as "option ARMs." These mortgages offer borrowers the choice to pay less than the required interest, which is then added to the principal while the interest rate can adjust upward. Because of this setup, many borrowers are unable to repay the mortgage once the interest rates go up. Which of the following phrases best describes this scenario?

legal but not ethical

18) Jaronda founded Diamond Communications Inc. in 1993. Ten years later, the company went public. Despite Jaronda's death in 2005, the company reported a 75 percent increase in revenue in 2006. Which of the following characteristics of a publicly traded company does this scenario best exemplify?

legal personality

62) Angelica is the CEO of Sandhaven Ltd., a publicly traded company. The shareholders want Angelica on the board of directors despite her recent appointment as the CEO. This decision of the shareholders is most likely because Angelica is

likely to provide the board with valuable inside information.

47) A company scientist at a biotechnology company decides to work on his own research project, hoping to eventually start his own firm, rather than on the project he was assigned. However, the company's stockholders are unaware of this situation. This is an example of a(n) ________ in the context of a principal-agent problem.

moral hazard

51) Rajat Gupta's role in providing inside information to Galleon Group for the benefit of Galleon Group's stockholders and himself is an example of

moral hazard.

74) Ethics is

not synonymous with law.

55) Shareholders of public companies need to appoint a board of directors to represent their interests because

of the separation of ownership and control.

30) Which of the following could most likely have prevented the accounting scandals of the early 2000s and the global financial crisis?

practicing effective corporate governance

35) Yelena, the CEO of Andron Inc., reports to the board of directors appointed by the shareholders of Andron. Based on shareholder suggestions, the board ties Yelena's compensation to the performance of Andron. Due to this pressure, Yelena begins devoting extra time to projects and undertakes other activities to ensure that she has job security and that she receives adequate compensation. The reasons why the board ties Yelena's compensation to firm performance is to overcome

principal-agent problem.

33) CPA Inc. is a publicly traded company. The stockholders of this company delegate the authority to make decisions for the company to a CEO named Joaquin. The stockholders expect Joaquin to make decisions that will benefit the company. However, Joaquin begins to find ways to maximize his total compensation, which hinders CPA's performance. This scenario reflects

principal-agent problems.

21) Which of the following characteristics of a public stock company deals with principals and agents?

separation of legal ownership and management control

56) Megan is a graduate student pursuing a course in business. Presented with the case of a company's unethical behavior, Megan wonders if the company's board of directors should ask the CEO to step down. Having a strong belief in Michael Porter's idea of value creation, Megan is most likely to conclude that company's board of directors

should ask the CEO to step down because it has a greater obligation toward society.

81) The MBA oath first developed at Harvard Business School and now signed by students at over 300 business schools is modeled after

the Hippocratic oath in medicine.

69) Which of the following is a major issue at the forefront of CEO compensation in recent years?

the absolute size of the CEO pay package compared with the pay of the average employee

31) In public stock companies, which of the following expectations of principals is most likely to lead to principal-agent problems?

the expectation that the agent will act in the principal's best interest

29) Grameen Bank in Bangladesh was founded to provide microcredit to impoverished farmers who wanted to start their own entrepreneurial ventures that would help themselves climb out of poverty. This best exemplifies Michael Porter's suggestion that

the largest but poorest socioeconomic group can yield significant business opportunities.

25) Which of the following could be used as an example of why a stakeholder strategy approach to business has shortcomings?

the nonsustainable debt levels incurred by sovereign governments to fund social programs

32) Which of the following is the source of the principal-agent problem in publicly traded companies?

the separation of ownership and control

42) In a public stock company, senior executives, such as the CEO, face agency problems when

they delegate authority of strategic business units to general managers.

66) Which of the following best explains why a board of directors may grant stock options as part of a compensation package?

to align incentives between shareholders and management

16) Gary owns shares in a company called Archibald Industries Inc. The company's financial performance has been declining over the past few months, and the value of its stock has been decreasing. Gary wants to proactively cut his losses and therefore sells his shares. Anneke, a trading enthusiast, buys shares in Archibald Industries because she believes that the share prices cannot go anywhere but up. Which of the following characteristics of a public stock company does this scenario best exemplify?

transferability of investor ownership