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Answer Key
1. True
2. True
3. False
4. True
5. False
6. True
7. False
8. False
9. True
10. False
11. True
12. True
13. True
14. True
15. True
16. True
17. False
18. False
19. False
20. True
21. True
22. False
23. True
24. True
25. True
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Page 2
26. True
27. False
28. False
29. False
30. True
31. False
32. True
33. True
34. True
35. True
36. False
37. True
38. True
39. True
40. True
41. False
42. True
43. False
44. False
45. False
46. True
47. True
48. True
49. False
50. True
51. False
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52. False
53. True
54. True
55. False
56. False
57. True
58. True
59. True
60. False
61. True
62. False
63. True
64. True
65. True
66. True
67. True
68. True
69. c
70. d
71. b
72. d
73. c
74. b
75. c
76. d
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77. d
78. b
79. b
80. c
81. a
82. a
83. b
84. d
85. d
86. b
87. a
88. a
89. b
90. b
91. d
92. b
93. b
94. d
95. c
96. b
97. d
98. b
99. b
100. b
101. a
102. b
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103. c
104. d
105. b
106. c
107. c
108. b
109. d
110. c
111. b
112. a
113. d
114. c
115. b
116. d
117. c
118. c
119. a
120. d
121. c
122. d
123. a
124. c
125. a
127. d
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128. d
129. a
130. a
131. b
132. b
133. d
134. b
135. The separation of owners and managers creates an agency relationship. An agency relationship exists when a
principal hires an agent as a decision-making specialist to perform a service. Some problems that result from the agency
relationship between owners and managers include the potential for a divergence of interests and a lack of direct control
of the firm by shareholders. Managerial opportunism is the seeking of self-interest with guile. It is both an attitude and a
set of behaviors, which cannot be perfectly predicted from the agent’s reputation. Top executives may make strategic
decisions that maximize their personal welfare and minimize their personal risk, such as excessive product diversification.
Decisions such as these prevent the maximization of shareholder wealth, which is supposed to be the top executives’
priority. Although shareholders implement corporate governance mechanisms to protect themselves from managerial
opportunism, these mechanisms are imperfect. Agency costs include the costs of managerial incentives, monitoring costs,
enforcement costs, and the individual financial losses incurred by principals (owners of the firm) because governance
mechanisms cannot guarantee total compliance by the agents (managers).
136. The market for corporate control is composed of individuals and firms who buy ownership positions in (e.g., take
over) potentially undervalued firms to form a new division in an established firm or to merge the two previously separate
firms. The target firm’s top management team is usually replaced because it is assumed to be partly responsible for
formulating and implementing the strategy that led to poor firm performance. The market for corporate control is
(supposedly) triggered by low corporate performance by a firm relative to competitors in its industry. Thus, the market for
corporate control should act as a control mechanism for corporate governance that leads to the replacement of under-
performing executives. But, the market for corporate control is not an efficient governance mechanism because in reality
many of the firms taken over have above-average performance. Hostile takeovers, on the other hand, are typically
triggered by poor performance. Some managers have sought to buffer themselves from the effect of the market for
corporate control (hostile takeovers) by instituting golden parachutes that will pay the managers significant extra
compensation if the firm is taken over. Those and other takeover defenses are intended to increase the costs of mounting a
takeover and reducing the managers’ risk of losing their jobs. Examples of takeover defenses include asset restructuring,
changes in the financial structure of the firm, reincorporation in another state, and greenmail. These defense tactics are
controversial and the research on their effectiveness is inconclusive. Most institutional investors oppose them.
137.
Governance mechanisms focus on the control of managerial decisions to ensure that the interest of shareholders, the most
important stakeholder, will be served. But shareholders are just one stakeholder along with product market stakeholders
(e.g., customers, suppliers, and host communities) and organizational stakeholders (e.g., managerial and nonmanagerial
employees). These stakeholders are important as well. Therefore, at least the minimal interests or needs of all stakeholders
must be satisfied through the firm’s actions. Otherwise, dissatisfied stakeholders will withdraw their support from one firm
and provide it to another (e.g., employees will exit and seek another employer, customers seek other vendors, etc.). Some
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Top-level executives are monitored by the Board of Directors. All corporate stakeholders are vulnerable to unethical
behaviors by the firm. If the image of the firm is tarnished, the image of customers, suppliers, shareholders, and Board
members is also tarnished. Top-level managers, as the agents who have been hired to make decisions that are in
shareholders’ best interests, are ultimately responsible for the development and support of an organizational culture that
allows unethical decisions and behaviors. The Board of Directors has the power and responsibility to enforce this
expectation.
The decisions and actions of a corporation’s Board of Directors can be an effective deterrent to unethical behaviors. The
Board has the power to hold top managers accountable for unethical actions as they can hire and fire these managers.
Thus, the Board of Directors, which holds a position above the firm’s highest-level managers, holds considerable power
over top-level executives and can set and enforce standards for ethical behaviors within the organization.
138. Executive compensation, especially long-term incentive compensation, is complicated. First, the strategic decisions
made by top-level managers are typically complex and non-routine; as such, direct supervision of executives is
inappropriate for judging the quality of their decisions. Because of this, there is a tendency to link the compensation of
top-level managers to measurable outcomes such as financial performance. Second, an executive’s decision often affects a
firm’s financial outcomes over an extended period of time, making it difficult to assess the effect of current decisions on
the corporation’s performance. In fact, strategic decisions are more likely to have long-term, rather than short-term, effects
on a company’s strategic outcomes. Third, a number of other factors affect firm performance. Unpredictable economic,
social, or legal changes make it difficult to discern the effects of strategic decisions. Thus, although performance-based
compensation may provide incentives to managers to make decisions that best serve shareholders’ interests, such
compensation plans alone are imperfect in their ability to monitor and control managers.
Although incentive compensation plans may increase firm value in line with shareholder expectations, they are subject to
managerial manipulation. For instance, annual bonuses may provide incentives to pursue short-run objectives at the
expense of the firm’s long-term interests. Supporting this conclusion, some research has found that bonuses based on
annual performance were negatively related to investments in R&D, which may affect the firm’s long-term strategic
competitiveness. Although long-term performance-based incentives may reduce the temptation to underinvest in the short
run, they increase executive exposure to risks associated with uncontrollable events, such as market fluctuations and
industry decline. Long-term incentives may not be highly valued by a manager: thus, firms may have to overcompensate
managers when they use long-term incentives.
139. The three internal corporate governance mechanisms are: ownership concentration, the Board of Directors, and
executive compensation. Ownership concentration is based on the number of large-block shareholders and the percentage
of shares they own. With significant ownership percentage, institutional investors, such as mutual funds and pension
funds, are often able to influence top executives’ strategic decisions and actions. Thus, unlike diffuse ownership, which
tends to result in relatively weak monitoring and control of managerial decisions, concentrated ownership produces more
active and effective monitoring of top executives. An increasingly powerful force in corporate America, institutional
owners are actively using their positions of concentrated ownership in individual companies to force managers and Boards
of Directors to make decisions that maximize a firm’s value. These owners (e.g., CalPERS) have caused poorly
performing CEOs to be ousted from the firm. The Board of Directors, elected by shareholders, is composed of insiders,
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firm. Moreover, performance incentive plans can be subject to management manipulation. Consequently, executive
compensation is a far-from-perfect governance mechanism.
140. Ownership is typically separated from control in the large U.S. corporation. Owners (principals) hire managers
(agents) to make decisions that maximize the value of their firm. As risk specialists, owners diversify their risk by
investing in an array of corporations. As decision-making specialists, top executives are expected by owners to make
decisions that will result in earning above-average returns for which they are compensated. Thus, the typical corporation
is characterized by an agency relationship that is created when one party (the firm’s owners) hires and pays another party
(top executives) to use decision-making skills. Since owners may not possess the specialized skill to run a large company,
delegating these tasks to managers should produce higher returns for owners.
141.
Corporate governance structures used in Germany and Japan differ from each other and from the ones used in the United
States. Historically, the U.S. governance structure has focused on maximizing shareholder value. Banks have been at the
center of the German corporate governance structure, because as lenders, banks become major shareholders in the firms.
Shareholders usually allow the banks to vote their ownership positions, so banks have majority positions in many German
firms. The German system has other unique features. For example, German firms with more than 2,000 employees are
required to have a two-tier Board structure, separating the Board’s management supervision function from other duties that
it would normally perform in the United States (e.g., nominating new Board members). Historically, German executives
have not been dedicated to the maximization of shareholder value, because private shareholders rarely have major
ownership in German firms, nor do larger institutional investors play a significant role.
Attitudes toward corporate governance in Japan are affected by the concepts of obligation, family, and consensus. Japan
continues to follow a bank-based financial and corporate governance structure compared to the market-based financial and
corporate governance structure in the United States. In addition, Japanese firms belong to keiretsu, groups of firms tied
together by cross-shareholding. In many cases, the main-bank relationship of the firm is part of a keiretsu. However, the
influence of banks in monitoring and controlling managerial behavior and firm outcomes is beginning to lessen and a
minor market for corporate control is emerging.
Chinese corporate governance has become stronger in recent years. There has been a decline in equity held in state-owned
enterprises, but the state still dominates the strategies employed by most firms. Firms with higher state ownership tend to
have lower market value and more volatility in those values over time. In a broad sense, the Chinese governance system
has been moving toward the Western model in recent years. For example, YCT International recently announced that it
was strengthening its corporate governance with the establishment of an audit committee within its Board of Directors,
and appointing three new independent directors. In addition, recent research shows that the compensation of top
organization’s overall structure and strategic direction. Three internal governance mechanisms (ownership concentration,
the Board of Directors, and executive compensation) and an external mechanism (the market for corporate control) are
used in U.S. corporations. Unfortunately, corporate governance mechanisms are not always successful.
b.
False
2. While the implementation of the Sarbanes-Oxley Act in 2002 has been controversial to some, most believe that it has
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had positive results in terms of protecting stakeholders and certain stockholder interests.
a.
True
b.
False
3. In the United States, the members of the Board of Directors are a firm’s key stakeholders and a company’s legal owners.
a.
True
b.
False
4. In the modern U.S. corporation, the ownership and managerial control of the firm are separated.
a.
True
b.
False
5. Generally, the Board of Directors can be classified as insiders, unrelated insiders, outsiders, and unrelated outsiders.
a.
True
b.
False
6. Executive compensation is a governance mechanism that seeks to align the interests of managers and owners through
salaries, bonuses, and long-term incentive compensation such as stock awards and options.
a.
True
b.
False
7. A Board composed primarily of outside directors will have better insights as to the firms intended strategic initiatives,
the reasons for the initiatives, and the outcomes expected from them than will inside directors.
a.
True
b.
False
8. Research evidence suggests that ownership concentration is associated with lower levels of firm diversification, which
conforms to the interests of stockholders.
a.
True
b.
False
9. Long-term incentives facilitate a Board of Directors’ pay-related decisions designed to avoid potential agency problems
by linking managerial compensation to the wealth of common shareholders.
a.
True
b.
False
10. Amelia Smith is the sole owner of the successful restaurant chain, Amelia’s Café. Ms. Smith has taken a no-interest
loan from the company in order to build a luxurious seaside house for herself in Carmel, California. This constitutes a
classic agency problem.
a.
True
b.
False
11. Scandals at Enron, WorldCom, and HealthSouth illustrate the negative effects of poor ethical behavior on a firm’s
efforts to satisfy stakeholders.
a.
True
b.
False
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12. Ownership of many modern corporations is now concentrated in the hands of institutional investors rather than
individual stockholders.
a.
True
b.
False
13. Failures of corporate internal controls and inadequate internal control systems allowed unethical executives at such
companies as Enron and WorldCom to act in their own self-interest.
a.
True
b.
False
14. The market for corporate control may not be as efficient as a governance device as theory suggests because takeover
targets are not always low performers with weak governance.
a.
True
b.
False
15. The top management of RavenCrest, Inc. have significant stock options in RavenCrest. They are therefore more likely
to gain in making an agreement to be acquired, especially if they have golden parachutes.
a.
True
b.
False
16. A powerful CEO would oppose the appointment of a lead director on the Board of Directors.
a.
True
b.
False
17. For top-level managers, Board acceptance of the acquiring firm’s offer usually leads to job loss because the acquiring
firm wants new leadership. If the offer is refused, however, the job loss risk is minimal.
a.
True
b.
False
18. DDD MetalWorks plans to go public in the next 2 years. In order to be listed on the New York Stock Exchange, the
firm will need to restructure its present Board of Directors, which is made up of a majority outside independent directors
to a Board of Directors that is dominated by insiders and related outsiders.
a.
True
b.
False
19. When the option strike prices in an executive stock option-based compensation plan have been lowered it is usually a
defense to a hostile takeover.
a.
True
b.
False
20. Critics advocate reforms to ensure that independent outside directors represent a significant majority of the total
membership of the Board. But outsider-dominated Boards may emphasize the use of financial as opposed to strategic
controls. The risk of reliance on financial controls is that they may encourage managers to make decisions to maximize
their interests and reduce their employment risk.
a.
True
b.
False
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21. Large-block shareholders typically own at least 5 percent of a corporation’s issued shares.
a.
True
b.
False
22. Foreign investors are playing a relatively minor role in the governance of firms in many countries.
a.
True
b.
False
23. Ethically responsible companies design and use governance mechanisms that will at least minimally satisfy
stakeholders’ interests.
a.
True
b.
False
24. In modern corporations—especially those in the United States and United Kingdom—a primary objective of corporate
governance is to ensure that the interests of top-level managers are aligned with the interests of shareholders.
a.
True
b.
False
25. The separation of the positions of CEO and chairperson of the Board of Directors reduces the power of the CEO over
firm governance practices.
a.
True
b.
False
26. Boards with many members from the firm’s top management team tend to have weak monitoring and control systems
for managerial decisions.
a.
True
b.
False
27. A top-level manager’s reputation is a dependable predictor of his/her future behavior.
a.
True
b.
False
28. The way that U.S. corporate Boards of Directors are presently structured, they have little influence on the unethical
behavior of top management.
a.
True
b.
False
29. Individual shareholders with small ownership percentages are less dependent on the Board of Directors to represent
their interests than are large block shareholders.
a.
True
b.
False
30. One of the changes to enhance the effectiveness of the Board of Directors is the creation of a “lead director” role that
has strong powers with regard to the Board agenda and oversight of non-management Board member activities.
a.
True
b.
False
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31. Managers in firms that have been subjects of hostile takeovers usually find that their value to the new firm has been
enhanced because of their in-depth insider knowledge.
a.
True
b.
False
32. As globalization grows, adequate corporate governance is becoming an important requirement for doing business with
a foreign firms and in foreign countries.
a.
True
b.
False
33. Stock option repricing where the strike price value of the option has been lowered from its original position sometimes
happens when firm performance is poor.
a.
True
b.
False
34. An agency relationship exists when one or more persons (the principal or principals) hire another person or persons
(the agent or agents) as decision-making specialists to perform a service.
a.
True
b.
False
35. An advantage of severance packages is that they may encourage top-level managers to accept takeover bids that are
attractive to shareholders.
a.
True
b.
False
36. Executive compensation is considered an external corporate governance mechanism because it determined in part by
market forces.
a.
True
b.
False
37. Corporate governance mechanisms are designed to ensure that top managers make strategic decisions that best serve
the interests of the entire group of stakeholders.
a.
True
b.
False
38. Recent emphasis on corporate governance stems mainly from the failure of corporate governance mechanisms to
adequately monitor and control top-level managers’ decisions.
a.
True
b.
False
39. In recent years, the number of individuals who are large-block shareholders have declined and been replaced by
institutional owners such as mutual funds and pension funds.
a.
True
b.
False
40. In the United States, the primary goal of a firm is to maximize profits to provide a financial gain to shareholders.
a.
True
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b.
False
41. The three internal corporate governance mechanisms are ownership concentration, Board of Directors, and the market
for corporate control.
a.
True
b.
False
42. Large German firms must include employees, union members, and shareholders in the formal governance structure.
a.
True
b.
False
43. The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions related to consumer protection,
systemic risk oversight, capital requirements for banks, but not for executive compensation.
a.
True
b.
False
44. The separation of ownership and control is the most effective means used by firms to prevent managerial opportunism.
a.
True
b.
False
45. Because top management decisions are usually complex and nonroutine, determining the quality of executive
performance is beyond the power of Boards of Directors.
a.
True
b.
False
46. Agency costs include incentives for executives, monitoring, enforcement costs, and any individual financial losses
incurred by principals.
a.
True
b.
False
47. Corporate governance involves oversight in areas where owners, managers, and members of Boards of Directors may
have conflicts of interest.
a.
True
b.
False
48. Hedge funds, as part of the market for corporate control, identifies a firm that is underperforming and then invests in it
with the goal of improving that firm’s performance.
a.
True
b.
False
49. Institutional owners, despite their size, are usually unable to discipline ineffective top managers and cannot influence a
firm’s choice of strategies and overall strategic direction.
a.
True
b.
False
50. If a stakeholder is dissatisfied with a firm, it will withdraw its support and give it to another firm.
a.
True
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b.
False
51. In general, when governance mechanisms are strong, managers have free rein in their decisions.
a.
True
b.
False
52. Both top executives and owners of the firm wish to diversify the firm to reduce risk.
a.
True
b.
False
53. The market for corporate control is composed of individuals and firms that buy ownership positions or take over
potentially undervalued corporations and make changes to those corporations, including the replacement of the top
managers.
a.
True
b.
False
54. Attitudes toward corporate governance in Japan are affected by the concepts of obligation, family, and consensus.
a.
True
b.
False
55. The increased use of the market for corporate control has decreased the sophistication and variety of managerial
defense tactics that are used in takeovers.
a.
True
b.
False
56. As a rule, shareholders prefer more product diversification than do managers because shareholders wish to reduce risk
and maximize wealth.
a.
True
b.
False
57. Research suggests that institutional activism may not have a strong direct effect on firm performance but may
indirectly influence the targeted firm’s strategic decisions, including those concerned with international diversification and
innovation.
a.
True
b.
False
58. Corporate governance is the set of mechanisms used to manage the relationship among stakeholders and to determine
and control the strategic direction and performance of an organization.
a.
True
b.
False
59. Because of recent ineffective performance, Boards of Directors are experiencing increasing pressure from
shareholders, lawmakers, and regulators to be more effective in preventing managers from acting in their own interest.
a.
True
b.
False
60. More intense application of governance mechanisms such as mandated by Sarbanes Oxley and Dodd-Frank may cause
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firms to take on fewer risky projects and thus increase potential shareholder wealth.
a.
True
b.
False
61. The performance of individual Board members and entire Boards are being evaluated more formally and with greater
intensity than in years past.
a.
True
b.
False
62. Well-designed stock option-based compensation plans should have the option strike prices substantially lower than the
current stock prices.
a.
True
b.
False
63. The primary role of the Board of Directors is to monitor and control top-level executives to protect owners’ interests.
a.
True
b.
False
64. Corporate governance is a means to establish harmony between parties (the firm’s owners and its top-level managers)
whose interests may conflict.
a.
True
b.
False
65. The use of executive compensation as a governance mechanism is more challenging to firms implementing
international strategies than those strictly operating domestically.
a.
True
b.
False
66. In a large number of family owned firms, ownership and managerial control are not separated.
a.
True
b.
False
67. The Dodd-Frank Wall Street Reform and Consumer Protection Act is the most sweeping set of financial and
regulatory reforms in the United States since the Great Depression.
a.
True
b.
False
68. The most effective defense against a hostile takeover is the poison pill strategy.
a.
True
b.
False
Indicate the answer choice that best completes the statement or answers the question.
69. Which of the following is FALSE about corporate governance in China?
a.
The Chinese governance system may be tilting toward the Western model.
b.
With increasing frequency, the compensation of top executives of Chinese companies is closely related to
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prior and current financial performance of the firm.
c.
The state still uses direct and/or indirect controls to influence the strategies employed by most firms.
d.
Firms with higher state ownership tend to have lower market value and more volatility in those values over
time.
70. The CEO and Chairman of the Board of Directors Alta Corp. is dismayed by a lack of effort and insights his directors
provide during Board meetings. The directors are all outsiders, experienced, and run their own successful firms. The
CEO/chair genuinely seeks their greater involvement. What would you recommend?
a.
Requiring that the directors own stock in the company.
b.
Establishing a formal process to evaluate the Board’s performance.
c.
Electing a lead director.
d.
All of these options are correct.
71. As ownership of the corporation is diffused, shareholders’ ability to monitor managerial decisions:
a.
increases.
b.
decreases.
c.
remains constant.
d.
is eliminated.
72. The ownership of major blocks of stock by institutional investors have resulted in all of the following EXCEPT:
a.
making CEOs more accountable for their performance.
b.
challenges to the decisions of Boards.
c.
focusing attention on ineffective Boards of Directors.
d.
a direct effect on firm performance.
73. In the United States, a firm’s key stakeholder(s) is(are) the:
a.
government.
b.
executives.
c.
shareholders.
d.
customers.
74. Simon Leagreet, the Chairperson and CEO of L-EVA Industries, Inc., has long been the major power at L-EVA. A
majority of the directors are concerned that while Mr. Leagreet has been responsible for the firm’s earning above-average
returns, he has been displaying a tendency toward personal extravagance at the firm’s expense. In order to limit Mr.
Leagreet’s power, the Board of Directors plans to:
a.
elect an insider as the lead director.
b.
appoint another individual as chairperson of the Board of Directors.
c.
require Mr. Leagreet to personally certify the firm’s financial reports.
d.
reduce the size of the stock option package provided to Mr. Leagreet.
75. The separation between firm ownership and management creates a(n) ____ relationship.
a.
governance
b.
control
c.
agency
d.
dependent
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76. In Japan, the principal source of the active monitoring of large companies comes from:
a.
Boards of Directors.
b.
stock brokerage companies.
c.
the government.
d.
banks.
77. A major conflict of interest between top executives and owners, is that top executives wish to diversify the firm in
order to ____, whereas owners wish to diversify the firm to ____.
a.
generate free cash flows; reduce the risk of total firm failure
b.
increase the price of the firm’s stock; increase the dividends paid out from free cash flows
c.
reduce the risk of total firm failure; reduce their total portfolio risk
d.
reduce their employment risk; increase the company’s value
78. The CEO of Skyco, a publicly-traded company that has been earning below-average returns, has been publicly
criticized by shareholders for persuading the Board of Directors to give her interest-free loans, for having the company
purchase and furnish a lavish apartment in Paris for her personal use on her twice-yearly trips there, and for excessive
stock options. The CEO’s behavior may be indication of:
a.
reasonably compensating a CEO.
b.
a weak Board of Directors.
c.
the laxity of institutional investors.
d.
the difference in risk propensity between owners and managers.
79. The market for corporate control serves as a means of governance when:
a.
the firm is overpriced in the market.
b.
internal controls have failed.
c.
the corporation has greatly exceeded performance expectations.
d.
the top management team’s interests and the owners’ interests are aligned.
80. Several members of the Board of Directors of American Textile Products (ATP) have proposed creating the position
of lead director. What circumstances would most likely have initiated this proposal?
a.
ATP has been the initiator of several hostile takeovers in the last 2 years.
b.
The Board has been successful in reducing the percentage of CEO pay that is composed of stock options.
c.
The CEO/chairperson of the Board has been suspected of opportunistic behavior.
d.
The firm is traded on the New York Stock Exchange and must change its corporate governance to comply with
the NYSE’s new rules.
81. An agency relationship exists when one party delegates:
a.
decision-making responsibility to a second party.
b.
financial responsibility to employees.
c.
strategy implementation actions to functional managers.
d.
ownership of a company to a second party.
82. The Board of Directors of CyberScope, Inc., is designing a stock option plan for its CEO that will motivate the CEO
to increase the market value of the firm. Consequently, the Board is: