Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Which of the following statements is false?
A) The conflict of interest between managers and investors derives from the separation of ownership and
control in a corporation.
B) Any discussion of corporate controls—the system of controls, regulations, and incentives designed to
prevent fraud—is a story of conflicts of interest and attempts to minimize them.
C) Once control and ownership are separated a conflict of interest arises between the owners and the
people in control of a corporation.
D) The separation of ownership and control is perhaps the most important reason for the success of the
corporate organizational form. Because any investor can hold an ownership stake in a corporation,
investors are able to diversify and thus, with no costs, reduce their risk exposures.
2) Which of the following statements is false?
A) The incentives come from owning stock in the company and from compensation that is sensitive to
performance.
B) The role of the corporate governance system is to mitigate the conflict of interest that results from the
combination of ownership and control without unduly burdening managers with the risk of the firm.
C) Punishment comes when a board fires a manager for poor performance or fraud, or when, upon failure
of the board to act, shareholders or raiders launch control contests to replace the board and
management.
D) The corporate governance system attempts to align interests by providing incentives for taking the
right action and punishments for taking the wrong action.
3) Which of the following is an example of an agency problem?
A) Managers not working as diligently if they are not the sole owner of the business.
B) The board of directors firing an incompetent manager.
C) The manager owning a great deal of stock in the company.
D) A corporate raider attempting to purchase the company.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
4) What is corporate governance?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
5) Directors who are employees, former employees, or family members of employees are called
A) Managing Directors.
B) Independent Directors.
C) Inside Directors.
D) Gray Directors.
6) Directors who are not as directly connected to the firm but who have existing or potential business
relationships with the firm are called
A) Gray Directors.
B) Independent Directors.
C) Advising Directors.
D) Inside Directors.
7) Directors who are not employees, former employees, or family members of employees and who do not have
existing or potential business relationships with the firm are called
A) Monitoring Directors.
B) Independent Directors.
C) Gray Directors.
D) Inside Directors.
8) Which of the following statements is false?
A) The shareholders as a group elect a board of directors to monitor managers. The directors themselves,
however, have the same conflict of interest–monitoring is costly and in many cases directors do not get
significantly greater benefits than other shareholders from monitoring the managers closely.
B) In principle, the board of directors hires the executive team, sets its compensation, approves major
investments and acquisitions, and dismisses executives if necessary.
C) In the United States, the board of directors has a clear fiduciary duty to protect the interests of both the
owners of the firm (the shareholders) and the interests of other stakeholders in the firm (such as the
employees).
D) When the ownership of a corporation is widely held, no one shareholder has an incentive to bear the
cost of monitoring, because she bears the full cost of monitoring but the benefit is divided among all
shareholders.
9) Tammy is a member of the Board of Directors of Moon Corporation. Her husband is the manager of a large
division. What type of director is Tammy?
A) Inside director.
B) Outside director.
C) Gray director.
D) Resident director.
10) Which of the following statements is false?
A) Researchers have hypothesized that boards with a majority of outside directors are better monitors of
managerial effort and actions.
B) Studies have found that firms with independent boards make fewer value–creating acquisitions but are
more likely to act in shareholders’ interests if targeted in an acquisition.
C) One early study showed that a board was more likely to fire the firm’s CEO for poor performance if the
board had a majority of outside directors.
D) Although the firm’s stock price increases on the announcement of its addition of an independent board
member, the increased firm value appears to come from the potential for the board to make better
decisions on acquisitions and CEO turnover rather than from improvements in the firm’s operating
performance.
11) Which of the following statements is false?
A) A board is said to be classified when its monitoring duties have been compromised by connections or
perceived loyalties to management.
B) Even the most active independent directors spend only one or two days per month on firm business,
and many independent directors sit on multiple boards, further dividing their attention.
C) On a board composed of insider, gray, and independent directors, the role of the independent director
is really that of a watchdog.
D) Because independent directors’ personal wealth is likely to be less sensitive to performance than that of
insider and gray directors, they have less incentive to closely monitor the firm.
12) Which of the following statements is false?
A) When the CEO is also chairman of the board, the nominating letter offering a seat to a new director
comes from her. This process merely serves to reinforce the sense that the outside directors owe their
positions to the CEO and work for the CEO rather than for the shareholders.
B) Over time, most of the independent directors will have been nominated by the CEO. Even though they
have no business ties to the firm, they are still likely to be friends or at least acquaintances of the CEO.
C) Researchers have found the surprisingly robust result that larger boards are associated with greater
firm value and performance.
D) The CEO can be expected to stack the board with directors who are less likely to challenge her.
13) Which of the following statements is false?
A) In addition to the evidence that board independence matters for major activities such as firing CEOs
and making corporate acquisitions, researchers have found a strong connection between board
structure and firm performance.
B) Theoretical and empirical research support the notion that the longer a CEO has served, especially
when that person is also chairman of the board, the more likely the board is to become captured.
C) Most firms that have just gone public either as young companies or as older firms returning to public
status after a leveraged buyout (LBO) choose to start with smaller boards.
D) Boards tend to grow over time as members are added for various reasons. For example, boards are
often expanded by one or two seats after an acquisition to accommodate the target CEO and perhaps
one other target director.
14) According to the findings of researchers in the field, which of the following is most likely to be an effective
Board of Directors?
A) A small board with a large proportion of directors who are not employed by the company or other
companies with which it does business.
B) A small board with a large proportion of directors who are employed by the company or another
company that has a business relationship with the company.
C) A large board on which most directors have served a long time.
D) A large board on which most directors are employees.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
15) What is the difference between Inside, gray, and outside directors?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
16) Which of the following statements is false?
A) Increasing the pay–for–performance sensitivity comes with the added benefit of reducing manager’s
risk.
B) Stock and option grants give managers a direct incentive to increase the stock price to make their stock
or options as valuable as possible.
C) By tying compensation to performance, the shareholders effectively give the manager an ownership
stake in the firm.
D) During the 1990s, most companies adopted compensation policies that more directly gave managers an
ownership stake by including grants of stock or stock options to executives.
17) Which of the following statements is false?
A) The substantial use of stock and option grants in the 1990s greatly increased managers’
pay–for–performance sensitivity.
B) The optimal level of sensitivity of managers’ compensation to the performance of their firms depends
on the managers’ level of risk aversion, which is hard to measure.
C) While decreasing managers’ risk exposure, increasing the sensitivity of managerial pay and wealth to
firm performance does have some negative effects.
D) In the absence of monitoring, the other way the conflict of interest between managers and owners can
be mitigated is by closely aligning their interests through the managers’ compensation policy.
18) Billy, the CEO of Movin On Up Company, was granted stock options with an exercise price of $62.04 per
share. The following are the week–ending stock prices that occurred during the quarter:
Date
Stock Price
7–Sep–05
56.82
13–Sep–05
57.24
20–Sep–05
60.51
27–Sep–05
57.23
4–Oct–05
60.14
11–Oct–05
60.42
18–Oct–05
61.5
25–Oct–05
59.84
1–Nov–05
60.02
8–Nov–05
60.14
15–Nov–05
61.52
22–Nov–05
61.67
29–Nov–05
63.94
6–Dec–05
62.39
13–Dec–05
62.04
20–Dec–05
64
27–Dec–05
65.52
What is the most likely date on which the stock options were awarded?
A) 13–Sep–05
B) 11–Oct–05
C) 13–Dec–05
D) Not enough information to answer the question.
19) Billy, the CEO of Movin On Up Company, was granted stock options with an exercise price of $55.00 per
share. The following are the week–ending stock prices that occurred during the quarter:
Date
Stock Price
7–Sep–05
56.82
13–Sep–05
57.24
20–Sep–05
60.51
27–Sep–05
57.23
4–Oct–05
60.14
11–Oct–05
60.42
18–Oct–05
61.5
25–Oct–05
59.84
1–Nov–05
60.02
8–Nov–05
60.14
15–Nov–05
61.52
22–Nov–05
61.67
29–Nov–05
63.94
6–Dec–05
62.39
13–Dec–05
62.04
20–Dec–05
64
27–Dec–05
65.52
If Movin On Up engaged in the practice of backdating, which of the following is the most likely exercise
price for Billy’s options?
A) $65.52
B) $67.50
C) $65.00
D) $56.82
20) Which of the following statements is false?
A) Backdating refers to the practice of choosing the grant date of a stock option retroactively, so that the
date of the grant would coincide with a date when the stock price was at its low for the quarter or for
the year.
B) Unless it is reported in a timely manner to the IRS and to shareholders, and reflected in the firm’s
financial statements, backdating is illegal.
C) The use of backdating suggests that some executive stock option compensation may not truly have
been earned as the result of good future performance of the firm.
D) By backdating the option the executive receives a stock option that is already out–of–the–money, with a
strike price equal to the higher price on the supposed grant date.
21) Which of the following statements is false?
A) New SEC rules require firms to report option grants within two days of the grant date, which may help
prevent further abuses.
B) Studies have found evidence that the practice of timing the release of information to maximize the
value of CEO stock options is widespread.
C) Managers have an incentive to manipulate the release of financial forecasts so that good news comes
out before options are granted and bad news is delayed until after the options are granted.
D) The factor contributing most to the climb in CEO total compensation for the 1990s was the sharp
increase in the value of stock and options granted each year.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
22) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
23) Which of the following statements is false?
A) The relationship between managerial ownership and firm value is unlikely to be the same for every
firm, or even for different executives of the same firm.
B) Even with the risk benefits of separating ownership and control, there are still examples of corporations
in which the top managers have substantial ownership interests.
C) Academic studies do not support the notion that greater managerial ownership is associated with fewer
value–reducing actions by managers.
D) While increasing managerial ownership may reduce perquisite consumption, it also makes managers
harder to fire—thus reducing the incentive effect of the threat of dismissal.
24) Which of the following statements is false?
A) If managers have large ownership stakes, then shareholders are more likely to use compensation
policies or a stronger board to create the desired incentives.
B) If all else fails, the shareholders’ last line of defense against expropriation by self–interested managers is
direct action.
C) A shareholder resolution could direct the board to take a specific action, such as discontinue investing
in a particular line of business or country, or remove a poison pill.
D) Any shareholder can submit a resolution that is put to a vote at the annual meeting.
25) Which of the following statements is false?
A) Recently, shareholders have started organizing “no” votes. That is, when they are dissatisfied with a
board, they simply refuse to vote to approve the slate of nominees for the board.
B) One early study of proxy contests found that the announcement of a contest increased firm stock price
by 8% on average, even if the challenge was eventually unsuccessful and the incumbents won
reelection.
C) Shareholders’ only real role in governance is in electing the directors of the company.
D) Perhaps the most extreme form of direct action that disgruntled shareholders can take is to hold a
proxy contest and introduce a rival slate of directors for election to the board.
26) Which of the following statements is false?
A) One study found that firms with fewer restrictions on shareholder power performed worse than firms
with more restrictions during the 1990s.
B) Some large public pension funds, such as CalPERS (the California Public Employees Retirement
System), take an activist role in corporate governance.
C) In 2004 with the Walt Disney Company, major shareholders were dissatisfied with the recent
performance of Disney under long–time CEO and Chairman, Michael Eisner. They began an organized
campaign to convince the majority of Disney shareholders to withhold their approval of the reelection
of Eisner as director and chairman of the board.
D) Given the importance of shareholder action in corporate governance, researchers and large investors
alike have become increasingly interested in measuring the balance of power between shareholders and
managers in a firm.
27) Which of the following statements is false?
A) An active takeover market is part of the system through which the threat of dismissal is maintained.
B) When internal governance systems such as ownership, compensation, board oversight, and shareholder
activism fail, the one remaining way to remove poorly performing managers is by mounting a hostile
takeover.
C) Likely because hostile takeovers and internal governance systems are substitute mechanisms,
researchers have found that boards are less likely to fire managers for poor performance during active
takeover markets than they are during lulls in takeover activity.
D) The effectiveness of the corporate governance structure of a firm depends on how well protected its
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
28) What is the role of takeovers in corporate governance?