tango_gs

The main objectives of a corporate governance system are best described as to:

A) define the rights of shareholders, and to facilitate fair and equal treatment in dealings between management and other stakeholders.

B) facilitate open communication between management and stakeholders, and to most effectively utilize corporate assets.

C) eliminate or reduce conflicts of interest, and to use the company’s assets in a manner consistent with the stakeholders’ best interests.

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A corporate governance system generally focuses on the elimination or reduction of conflicts of interest, particularly between management and shareholders, as well as the prudent utilization of corporate assets for the benefit of investors and other stakeholders.

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Michael Tormey and Amy Arnett are the founding partners of McMillan Corporate Services. Founding the business was relatively straightforward and over the last 20 years, the expertise provided by Tormey and Arnett have been key to making McMillan a success. Every Friday afternoon, Tormey and Arnett meet to discuss the status of the business, and have decided to devote this week’s meeting to strategic alternatives. Tormey believes that while the partnership structure has served McMillan well during its history, it may be time to reform the business into a corporate structure. Arnett, however, is not so sure. Which of the following arguments would be most effective to convince Arnett that a corporate structure would be beneficial for McMillan? The corporate structure would:

A) provide more opportunities for raising capital, allow for easier transition of ownership, and reduce the liability that they as owners would incur.

B) allow for easier transition of ownership, reduce legal requirements associated with running the business, and create a legal separation between the owners and the business.

C) create a legal separation between the owners and the business, allow for fewer conflicts of interest, and reduce the liability that they as owners would incur.

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A partnership allows two or more people to start a business with few legal requirements. Disadvantages of the partnership structure include a limited ability to raise capital, unlimited liability for owners, and non-transferability of ownership. A corporation is a distinct legal entity that has rights similar to a person. Compared to a partnership, a corporation has a nearly unlimited ability to raise capital, ownership is easily transferable, and the legal separation between the business and its owners limits the liability of the business owners. Disadvantages to the corporate form include increase legal and regulatory requirements and increased conflicts of interest as a result of the separation between owners and managers of the business.

tango_gs

Which form of business is most likely to have conflicts of interest between managers and owners?

A) Corporation.  

B) Sole-proprietorship.

C) Partnership.





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Corporations are typically owned by shareholders who play no role in day-to-day management decisions. Instead, managers are hired to control and deploy the assets of the company, and supposedly do so in the shareholders’ best interest. This separation between ownership and management creates the potential for conflicts of interest. Note that in the case of partnerships and sole proprietorships, the owners and managers are one in the same.

tango_gs

Which of the following statements regarding advantages to the corporate form of business organization compared to other business forms is least accurate?

A) A corporation’s ability to raise capital is virtually unlimited.

B) It is unnecessary for an owner of a corporation to have knowledge or expertise in the industry in which a business operates.

C) Corporations are easily formed with few legal requirements.  





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Advantages to the corporate form of business include the ease of raising capital, the ease of the transferability of stock ownership, and the lack of expertise needed by owners of a corporation since managers control the business’ assets. A disadvantage of corporations is the fact that since corporations have many non-manager owners, they are subject to a great deal of legal requirements and regulations.

tango_gs

Mitchell Cash of Yost and Karl Consulting is comparing and contrasting sole proprietorships, partnerships, and corporations for a new client that is looking to start a business. Cash makes the following statements to the client:

Statement 1:	Sole proprietorships have potentially unlimited liability, but the liability for a corporate owner is limited to the amount of their investment.
Statement 2:	Sole proprietorships and partnerships have fewer corporate governance risks than corporations.
Statement 3:	In most cases, there is no legal distinction between the owner and the business within a sole-proprietor structure.

Regarding Cash’s statements:

A) Statements 1 and 3 are correct, but Statement 2 is incorrect.

B) Statements 2 and 3 are incorrect, but Statement 1 is correct.

C) all three statements are correct.

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Cash is correct with respect to all three statements

tango_gs

Which of the following statements about major business forms is least accurate?

A) A key benefit of the corporate form of business is the ease in transferring ownership.

B) The potential legal liability for the owner of a sole proprietorship is limited to the market value of the business.

C) In a sole proprietorship, there is no legal distinction between the business and its owners.

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In a sole proprietorship, there is no legal distinction between the business and its owner. In the event of losses or bankruptcy, creditors could theoretically go after the owner’s personal assets, resulting in unlimited liability.

tango_gs

The purpose of the board of directors is to act as an intermediary between shareholders and management to assure that management is acting in shareholders’ best interest. Which of the following is NOT a factor that may cause directors to align more closely with managers than shareholders?

A) Directors are responsible for CEO succession planning.

B) Directors receive excessive compensation.

C) Directors are employed by financial institutions that lend money to the firm.

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Succession planning for the CEO is one of the duties of the board of directors, and should not cause directors to align with management over shareholders. Factors that could cause directors to align more closely with management include:

• Lack of independence (i.e. family relationships, prior employment, or existing business relationships).
• Interlinked boards.
• Directors are overcompensated.

tango_gs

Jill Tangeman and Lawrence Winkelman are shareholders for Hilliard Electric Components, Inc. (HECI). Tangeman and Winkelman are concerned about potential conflicts of interest that may affect them as shareholders of HECI and decide to draft a letter to various HECI decision makers to ask them what they are doing to eliminate or reduce potential conflicts of interest.
The basic premise of Tangeman and Winkelman’s letter is that corporate governance systems should focus on two potential areas where decision makers may not act in shareholders best interests: conflicts between managers and shareholders, and conflicts between directors and shareholders.
Winkelman states in the letter than he is concerned about executive compensation. “Having too much executive wealth concentrated in employee stock options can lead to managers avoiding potentially risky projects that would actually maximize wealth for shareholders.” Tangeman adds her own comment: “The primary responsibility of the board of directors is to assure that shareholders’ interests are balanced with those of management when negotiating on issues such as compensation.” When the letter is complete, both sign it as shareholders in the company and mail out 12 copies.
The assertion made by Tangeman and Winkelman about the focus of corporate governance systems is:

A) invalid, and only Tangeman makes a correct statement in the letter.

B) valid, and only Winkelman makes a correct statement in the letter.

C) valid, and neither Winkelman or Tangeman make a correct statement in the letter.

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The assertion made by Tangeman and Winkelman is valid – one of the two main objectives of corporate governance is to eliminate or reduce conflicts of interest. The two primary areas for potential conflicts of interest in a corporation are conflicts between shareholders and management and conflicts between directors and shareholders.
Winkelman’s statement is incorrect. Executive compensation in the form of large amounts of stock options can cause managers to take on too much risk as the asymmetric payoff of those options means that managers can reap huge rewards if the risks pay off, but will not share in the losses if the risky projects fail. Note that managers taking too little risk is also a concern, but taking too little risk is a symptom of managers holding too much stock – not stock options. If the manager has the bulk of their wealth tied to company stock, the manager may want to avoid risky projects to protect the value of the stock even though the risky projects may do a better job of maximizing value for the firm’s shareholders.
Tangeman’s statement is incorrect in two respects. The most important roles for the board of directors is to institute long-term strategic objectives for the company and institute corporate values that will insure that business is conducted in an ethical and fair manner. Also – the board should not “balance shareholder and management needs” when negotiating with management in areas such as compensation. The board needs to determine management compensation with shareholders’ best interest as their sole consideration.

tango_gs

The principal-agent problem can best be described as:

A) the agent may act for his own well being rather than that of the principal.

B) the agent may act for the well being of management rather than that of the stakeholders.

C) the agent may act for the well being of the principal rather than that of the stakeholders.

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In a principal-agent relationship, one party (the agent) acts on behalf of another party (the principal). A principal-agent problem arises when the agent places his own interests ahead of the principal.

tango_gs

Which of the following scenarios is NOT an example of a principal-agent problem?

A) Top management is awarded large amounts of executive stock options.

B) A board member also serves as a consultant to the company.

C) A senior manager also serves as a director on the board of another company.

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A senior manager may serve on the board of another company so long as there are no other circumstances that may compromise objectivity. For example, problems arise if the boards of two companies are “interlinked” by way of managers of Company A serving on the board of Company B, and managers of Company B serving on the board of Company A.