Business Policy Chapter 12

3 corporate mechanisms used to align incentives between principals and agents

-executive compensation -market for corporate control -financial statement auditors, government regulators, and industry analysts

4 characteristics that make the public stock company an attractive corporate form

1. Limited liability for investors 2. transferability of investor ownership (trading stocks) 3. legal personality 4. separation of legal ownership and management control

To ensure that managers can reconnect economic and societal needs, Porter recommends that managers focus on three things within the shared value creation framework:

1. expand the customer base to bring in nonconsumers such as those at the bottom of the pyramid - the largest but poorest socioeconomic group of the world's population. 2. expand traditional internal firm value chains to include more nontraditional partners such as nongovernmental organizations. 3. Focus on creating new regional clusters (such as silicon valley).

Which of the following proves that GE's board of directors is significantly independent?

16 of the 17 directors are from outside the organization

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.

What was Goldman Sachs' rebuttal to SEC's claim that it defrauded investors?

It is up to the clients to assess the risks involved in any investment

Financial Performance

Michael Porter argued that many public companies have defined value creation too narrowly in terms of ___________________.

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

creating shared value

a concept that involves creating economic value for shareholders while also creating social value by addressing society's needs and challenges.

shared value creation framework

a model proposing that managers have a dual focus on shareholder value creation and value creation for society. recognizes that markets are defined not only by economic needs but also by societal needs. It also advances the perspective that externalities actually create internal costs. seeks to enhance a firm's competitiveness by identifying connections between economic and social needs, and then creating a competitive advantage by addressing these business opportunities.

leveraged buyout (LBO)

a single investor or group of investors buys, with the help of borrowed money (leveraged against the company's assets) the outstanding shares of a public company in order to take it private; the private owners often will restructure the company and eventually take it public again.

moral hazard

a situation in which information asymmetry increases the incentive of one party to take undue risks or shirk other responsibilities because the costs incur to the other party. knowing there is a high probability of being bailed out increases this. in the principal-agent relationship, this describes the difficulty of the principal to ascertain whether the agent has really put forth a best effort.

adverse selection

a situation that occurs when information asymmetry increases the likelihood of selecting inferior alternatives. In principal-agent relationships for example, this describes a situation in which an agent misrepresents his or her ability to do the job.

corporate governance

a system of mechanisms to direct and control an enterprise in order to ensure that it pursues its strategic goals successfully and legally. is about checks and balances and about asking the tough questions at the right time. Attempts to address the principal-agent problem.

agency theory

a theory that views the firm as a nexus of legal contracts. conflicts that arise are to be addressed in the legal realm. two specific agency problems that need to be overcome are adverse selection & moral hazard

Johan 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 startup recruits Johan based on his stated credentials without verifying them. 2 days into the job, Johan's team lead realizes that he does not know much of what he claimed to know during the interview. This scenario best exemplifies

adverse selection

business ethics

an agreed-upon code of conduct in business, based on societal norms. not synonymous with laws.

stock options

an incentive mechanism to align the interests of shareholders and managers, by giving the recipient the right to buy a company's stock at a predetermined price sometime in the future.

board of directors

appointed by shareholders to represent their interests. acts as the centerpiece of corporate governance. votes at shareholder meetings, generally in proportion to the amount of ownership, determine whose representatives are appointed to this.

principal-agent problem

can arise when an agent such as a manager, performing activities on behalf of the principal (the owner of the firm), pursues his or her own interests. happens bc of information asymmetry (agents are more informed than the principals)

poison pills

defensive provisions that kick in should a buyer reach a certain level of share ownership without top management approval. they retard an effective function of equity markets.

Inside Directors

generally part of the company's senior management team - such as the CFO and COO. Appointed by shareholders to provide the board with necessary information pertaining to the company's internal workings and performance. interests tend to align with management and the CEO rather than the shareholders.

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

Which of the following is an important external corporate-governance mechanism?

market for corporate control

Outside Directors

not employees of the firm. often senior executives from other firms or full-time professionals who are appointed to a board and serve on several boards simultaneously. More likely to watch out for the interests of the shareholders.

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

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

the separation of ownership and control

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

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

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.