Reading 33: Corporate Governance－LOS f based, social, structure, corporate, advantages

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CFA Institute Area 8-11, 13: Asset Valuation
Session 10: Equity Portfolio Management
Reading 33: Corporate Governance
LOS f: Explain the social responsibilities of the corporation in a "stakeholder society" and evaluate the advantages and disadvantages of a corporate governance structure based on stakeholder rather than shareholder interests.

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Under which of the following legal systems is shareholder protection the strongest?

A) Common law.

B) French civil law.

C) German civil law.

D) Scandinavian civil law.

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Answer and Explanation

Common law countries (England and its former colonies) provide the most protection to shareholders whereas French civil law provides the weakest protection to shareholders. German and Scandinavian civil law countries have shareholder protection between the two.

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Comparing the civil law system in France to other countries and its protection to investors, which of the following is most accurate?

A) Creditors are weakly protected but are more likely to receive collateral on their loan.

B) Creditors are strongly protected and are more likely to receive collateral on their loan.

C) Creditors are weakly protected and are less likely to receive collateral on their loan.

D) Creditors are strongly protected but are less likely to receive collateral on their loan.

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Answer and Explanation

Protection for debtholders varies internationally. Creditors have weak protection in France and stronger protection in the U.K. As an offset to the weaker protection, creditors are more likely to receive collateral on their loans in France.

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Shareholder protection under the civil law system in France is characterized by which of the following?

A) Shareholders are strongly protected and there are more shareholders of a larger size.

B) Shareholders are weakly protected and there are less shareholders of a larger size.

C) Shareholders are weakly protected but there are more shareholders of a larger size.

D) Shareholders are strongly protected but there are less shareholders of a larger size.

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Answer and Explanation

If the legal system does not provide shareholder protection, firms develop alternative means of monitoring management. In France, the legal system provides weak shareholder protection. Accordingly, in French civil law countries there are more large shareholders who have an incentive to monitor management.

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A firm is going to choose where to incorporate and how much debt to hold. If the firm was only interested in strengthening their corporate governance, the firm would:

A) incorporate in a civil law country and be highly levered.

B) incorporate in a common law country and be highly levered.

C) incorporate in a common law country and be minimally levered.

D) incorporate in a civil law country and be minimally levered.

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Answer and Explanation

If the firm were only interested in strengthening their corporate governance, the firm would incorporate in a common law country because this legal system provides greater shareholder protection than civil law countries. Being highly levered (carrying a lot of debt) would also likely improve corporate governance because the firm would not have excess cash to waste and management would be motivated to run the corporation leanly.