prashantsahni

Which of the following would enable a Board of Directors to act in the best long-term interest of the shareholders?

A) A majority of the Board of Directors is comprised of independent members and the Chairman of the Board is also a former Chief Executive Officer of the firm.

B) A majority of the Board of Directors is comprised of independent members and the Board meets regularly outside the presence of management.

C) There are Board members who are closely aligned with a firm supplier and the Board meets regularly outside the presence of management.

---

The Chairman of the Board, who is also the CEO or former CEO, may impair the Board members from expressing opinions contrary to management. Also, when Board members’ interests are closely aligned with a firm supplier, customer, pension advisor, etc., independence may be impaired.

prashantsahni

Which of the following prescriptions would least likely improve board of director effectiveness?

A) The board should have an independent chairman.

B) Directors should be subject to maximum equity positions.

C) Self-evaluations of boards should be performed.

---

Directors should be required to hold a minimum amount of equity, not limited to a maximum of how much equity they can hold.

prashantsahni

In which of the following situations would an active investor be the least effective monitor of management? The active investor holds a:

A) small block of liquid stock.

B) large block of illiquid stock.

C) small block of illiquid stock.

---

If the active investor holds a small block of stock, then they do not have as strong an incentive to monitor management as they would if they held more shares and hence had more at stake. If the stock were liquid, they would also be less likely to be an effective monitor of management because they can easily sell their shares if management misbehaves. If instead the stock was illiquid, the active investor would likely place pressure on management to change because they could not cash out as easily.

prashantsahni

Which of the following refers to the situation where an active investor does not own the majority of the firm’s shares but persuades other shareholders of her position?

A) The active investor has real control.

B) The active investor has contingent control.

C) The active investor has formal control.

---

An active investor must have control to effectuate change. To have control, the shareholder must have either a majority of the firm’s shares (formal control) or be able to persuade other minority shareholders of her position (real control).

prashantsahni

Which of the following is least likely to limit active investor effectiveness?

A) Active investors are strictly monitored as to their performance.

B) Managers may become too focused on short-term performance.

C) Active investors may liquidate their shares.

---

Active investors may not be effective monitors of management because active investors themselves are often unmonitored. Institutional (active) investors rarely face the same pressure that they apply to corporations. Their compensation is usually based on assets managed instead of performance, they are not subject to proxy fights, and they do not carry debt.

prashantsahni

Which of the following statements regarding bankruptcy as a mechanism for enforcing good corporate governance is most accurate?

A) Bankruptcy costs are substantial but bankruptcy does not discipline management to the extent expected.

B) Bankruptcy costs are comparatively minor but bankruptcy does not discipline management to the extent expected.

C) Bankruptcy costs are substantial and bankruptcy provides strong discipline against poor management.

---

Bankruptcy costs are substantial and include both direct and indirect costs. Bankruptcy does not actually discipline management to the extent expected. Managers are often able to retain their positions during a firm’s bankruptcy.

prashantsahni

A firm would like to issue new securities to fund a new project. The firm’s managers have been paid predominantly with equity-based compensation and now hold most of the firm’s stock. If the firm wants to motivate their managers to work harder, which of the following securities should be issued?

A) Shelf registered preferred stock.

B) Debt.

C) Common stock.

---

In terms of providing the strongest incentive for managers, the firm should issue debt. If the project is profitable and the firm has issued debt, the managers/owners won’t have to share their residual claim on profits with other common stock holders. By issuing debt, the manager/owners can more clearly see the end result of their efforts, and this will motivate them to perform better.
Additionally, debt provides an incentive effect relative to preferred stock because the firm will have a legally binding obligation to make payments on the debt and management will not be able to waste cash on extravagant projects and perks.

prashantsahni

Which of the following statements regarding debt and its effect on corporate health via corporate governance mechanisms is most accurate?

A) Debt is unambiguously beneficial.

B) In some situations it can be beneficial; in others it can be a detriment.

C) Debt is unambiguously detrimental.

---

In some situations debt can be beneficial; in others debt can be a detriment. It is beneficial when it motivates management to not waste cash. With the pressure to make periodic interest and principal payments, management does not have the luxury of spending cash on frivolous projects and perks. If the firm has no cash after paying the debtholders, it is detrimental because it prevents the firm from investing in valuable projects.

prashantsahni

Which of the following is NOT representative of a firm in a stakeholder society?

A) Employees are treated fairly and given extra benefits such as child care and extra family time off which makes them feel more secure and part of a community.

B) Because the firm is viewed favorably by the community it is extended tax breaks and favorable terms by creditors and suppliers.

C) Managers of the firm are under greater control by the stakeholders.

---

In a stakeholder society the social responsibilities of the corporation are to treat the employees fairly with respect to salaries, job security, training, child care, exercise facilities, family time off, etc. This results in the firm being viewed favorably by the community thus creditors offer better financing terms and suppliers offer better pricing and credit terms. By attempting to protect the best interests of all stakeholders the managers are left largely unmonitored thus there is less control of the management under a stakeholder society. In a stockholder society management is under greater control and scrutiny by the stockholders to perform well to maintain a high stock price.

prashantsahni

Which of the following statements regarding advantages and disadvantages in a stakeholder society is least accurate?

A) Profits are sacrificed in the short term for increased shareholder wealth in the long-run.

B) Stockholders and creditors may be hesitant to invest fearing that gains must be shared with other stakeholders.

C) Taxes are distributed more equitably under a stakeholder society than a shareholder society.

---

There is no evidence that taxes are redistributed more equitably under a stakeholder society where management and the board of directors redistribute taxes to the stakeholders versus a shareholder society where elected officials redistribute taxes.