Microeconomics, 4e (Hubbard/O’Brien)
Chapter 8 Firms, the Stock Market, and Corporate Governance
8.1 Types of Firms
1) Which of the following must a firm in a market economy do today to succeed?
A) Produce the goods and services that consumers want at a lower cost than consumers
themselves can produce.
B) Organize the factors of production into a functioning, efficient unit.
C) Have access to sufficient funds.
D) Market firms today must do all of these things.
2) Organizing a successful firm in a market economy has become ________ over the last
century.
A) legally impossible
B) politically impossible
C) less difficult
D) more difficult
3) Unlike firms that sell stock in financial markets, which are known as ________ firms,
companies like Facebook which do not sell stock in financial markets are known as ________
firms.
A) public; private
B) open; closed
C) corporate; proprietary
D) stock market; bond market
4) A sole proprietorship is
A) the easiest type of business to set up.
B) the most difficult type of business to set up.
C) the most expensive type of business to set up.
D) the least profitable type of business to set up.
5) Which type of business is the most difficult to set up?
A) sole proprietorship
B) partnership
C) corporation
D) There is no difference in the difficulty of establishment.
6) A corporation is the type of business has ________ government rules and regulations affecting
it.
A) no
B) the fewest
C) the most
D) only federal
7) Which type of business has the least government rules and regulations affecting it?
A) sole proprietorship
B) partnership
C) corporation
D) They all have the same set of rules and regulations affecting them.
8) As a form of business, a partnership
A) has limited liability.
B) has only one owner.
C) cannot issue stock.
D) has the most government rules and regulations affecting it.
9) How do a sole proprietorship and a corporation differ?
A) Proprietorships have unlimited liability while corporations have limited liability.
B) Corporations can issue stocks and bonds, while proprietorships cannot.
C) Corporations face more taxes than do proprietorships.
D) All of these are differences between the two types of businesses.
10) Assume you set up a sole proprietorship and your lawyer tells you that as the owner, you
could stand to lose your personal wealth if the business goes bankrupt. This means a sole
proprietorship
A) faces limited liability.
B) faces unlimited liability.
C) has little chance of succeeding.
D) is not a good type of business to set up.
11) Who controls a sole proprietorship?
A) stockholders
B) bondholders
C) the owner
D) all of these
12) A corporation is owned by its
A) board of directors.
B) stockholders.
C) employees.
D) CEO.
13) How does the owner of a sole proprietorship relate to the business?
A) The owner and the business are separate legal entities.
B) The owner and the business are not separate legal entities.
C) The assets of the owner are considered separate from the asset of the business.
D) None of these describe the legal relationship of the owner to the business.
14) In a typical year, ________ of new jobs are created by small firms.
A) less than 5 percent
B) 10 percent
C) 40 percent
D) 75 percent
15) Eighty-five percent of all firms employ ________ workers.
A) only one or two
B) fewer than 20
C) 50 or more
D) over 100
16) The owners of a ________ have a separate legal distinction from the business.
A) corporation
B) partnership
C) sole proprietorship
D) All of the above are correct.
17) What does limited liability mean?
A) The owners of the business are personally responsible for paying expenses incurred by the
business.
B) Only employees can have a claim on the assets of the business.
C) The personal assets of the owners cannot be claimed if the business is bankrupt.
D) Anybody with a liability against a firm can claim only what their liability refers to.
18) Which of the following is an advantage of starting a new business as a proprietorship?
A) The owner has limited personal liability.
B) A proprietorship has few government rules and regulations to comply with.
C) Business profits are not taxed.
D) A proprietorship can easily attain additional funding.
19) Jeremy is thinking of starting up a small business selling NASCAR memorabilia. He is
considering setting up his business as a sole proprietorship. What is one advantage to Jeremy of
setting up his business as a sole proprietorship?
A) As a sole proprietor, Jeremy would face limited liability.
B) As a sole proprietor, Jeremy would have the ability to share risk with shareholders.
C) As a sole proprietor, Jeremy would have both ownership and control over the business.
D) All of the above would be advantages of setting up his business as a sole proprietorship.
20) Jeremy is thinking of starting up a small business selling NASCAR memorabilia. He is
considering setting up his business as a sole proprietorship. What is one disadvantage to Jeremy
of setting up his business as a sole proprietorship?
A) As a sole proprietor, Jeremy would be taxed twice.
B) As a sole proprietor, Jeremy would not have control of the business.
C) As a sole proprietor, Jeremy would face unlimited liability.
D) As a sole proprietor, Jeremy would be subject to significant rules and regulations.
21) Which of the following is not an advantage of starting a new business as a corporation?
A) separation of ownership and business liability
B) enhanced ability to raise funds
C) ability to share risks
D) possibility of double taxation
22) How are corporate profits taxed in the United States?
A) Earnings are taxed first by state sales taxes and then as corporate profits at the Federal level.
B) Earnings are taxed first as personal income then as corporate profits at the Federal level.
C) Earnings are taxed first as corporate profits then as personal income after dividends are paid.
D) Corporate profits are not taxed at all.
23) Sole proprietorships are ________ type of business.
A) the most profitable
B) the least common
C) the most common
D) the least risky
24) Which is the least common type of business?
A) corporation
B) partnership
C) sole proprietorship
D) impossible to determine without further information
25) As a business type, corporations ________ in the United States.
A) earn the majority of revenues
B) are the most common
C) are the least common
D) are subject to the fewest taxes
26) Which type of businesses earns the majority of profits in the United States?
A) corporations
B) partnerships
C) sole proprietorships
D) none of these
27) Who controls a partnership?
A) the owners
B) stockholders
C) bondholders
D) employees
28) When a business is set up as a sole proprietorship, the owner of the business faces limited
liability.
29) The only type of business that faces limited liability is a corporation.
30) In the United States, corporate profits are taxed at the corporate level and then are taxed
again as personal income in the form of dividend payments.
31) Define a partnership.
32) How do unlimited and limited liability differ?
33) What are the advantages of setting up a corporation as opposed to a proprietorship or
partnership?
34) What type of business has the potential for double taxation of profits and why?
8.2 The Structure of Corporations and the Principal-Agent Problem
1) What is an inside director?
A) a movie director who also appears in the movie
B) a member of a corporate board of directors that is also a manager of the business
C) the CEO that is selected by the corporation’s board of directors
D) a board of director chair who has been in the job for at least three years
2) Corporate governance involves the way in which
A) the government nationalizes corporations.
B) the government licenses corporations.
C) a corporation is subject to government regulations.
D) a corporation is structured.
3) Who operates and controls a corporation in its day-to-day activities?
A) the board of directors
B) stockholders
C) employees
D) management
4) A corporation’s board of directors
A) hire the managers of the corporation.
B) control the day-to-day activities of the corporation.
C) are personally liable for the debts of the corporation.
D) are the sole owners of the corporation.
5) Stockholders
A) select the board of directors of a corporation.
B) select the employees of a corporation.
C) select the managers of a corporation.
D) all of the above
6) What do economists call the situation where a hired manager does not have the same interests
as the owners of the business?
A) conquest and control
B) a financial problem
C) a principal-agent problem
D) a financial intermediary problem
7) The person hired by a corporation’s board of directors to run the day-to-day operations of the
corporation is known as the
A) chairman of the board.
B) chief executive officer.
C) owner-manager.
D) corporate governor.
8) By tying the salaries of top corporate managers to the price of the corporation’s stock,
corporations hope to avoid
A) corporate governance.
B) conflict between the CFO and the CEO.
C) the principal-agent problem.
D) paying high salaries to their managers.
9) The existence of the principal-agent problem
A) increases the risk of buying stock in a corporation.
B) increases the risk of becoming the sole proprietor of a business.
C) implies that managers that have the same incentives as the board of directors.
D) does all of the above.
10) Corporations are legally owned by their shareholders.
11) The principal-agent problem that exists between shareholders and managers also exists
between managers and workers.
12) In a corporation, what are “inside directors” and “outside directors”?
13) Explain what potential conflict exists between shareholders in a corporation and the
corporation’s managers.
14) Explain the relationships between a corporation’s shareholders, its board of directors, and its
top managers.
15) Scott is a manager at a pool cleaning business. He has hired 10 workers to clean pools for
him and is considering what type of payment scheme he should set up for his workers. He can
pay each of his workers $10 per hour to clean pools, or he can pay his workers $20 for each pool
a worker cleans. (It takes 2 hours, on average, for an employee to clean a pool thoroughly.) If
Scott wants to maximize the number of pools his workers clean in one day, which payment
scheme should he use? Explain.
8.3 How Firms Raise Funds
1) How can a proprietorship or partnership raise funds for expansion?
A) borrow from someone or an institution willing to lend the funds
B) reinvest profit back into the business
C) take on a partner or more partners
D) Any of these would generate funds for expansion.
2) The central role of ________ in a market economy is bringing together savers and borrowers.
A) corporations
B) sole proprietors
C) financial intermediaries
D) stock exchanges
3) What takes place in the indirect finance market?
A) Part ownership of corporations is sold in the form of stocks.
B) Corporate and government bonds are sold to savers.
C) Deposits of savers are accepted and loans made to borrowers.
D) Government purchases of buildings and equipment are sold to the highest bidder.
4) Which of the following takes place in the direct finance market?
A) Firms borrow funds from banks.
B) Deposits from savers are accumulated and loans made to borrowers.
C) Ownership in corporations is sold in the form of preferred stock.
D) Banks offer savings accounts to customers.
5) If Southwest Airlines borrows $20 million from a bank to finance the renovation of their
corporate offices, this is an example of
A) a bond market transaction.
B) indirect finance.
C) a stock market transaction.
D) direct finance.
6) Southwest Airlines wants to raise $20 million to finance the renovation of their corporate
offices, and the company wishes to raise the funds through direct finance. Which of the
following methods could it use?
A) It could issue $20 million in stocks.
B) It could sell $20 million in bonds.
C) It could borrow $20 million from a bank.
D) It could choose either A or B.
7) A bond is a financial security that represents
A) ownership in a corporation.
B) the portion of profits paid to shareholders.
C) the interest rate paid on a share of stock.
D) a promise to repay a fixed amount of funds.
8) What is different about buying stocks and buying bonds?
A) A stock can possibly pay dividends forever, but bonds have a fixed number of payments.
B) Differences of opinion about a stock’s future may vary considerably but there is less
difference about a bond’s future.
C) The future growth of a stock is more uncertain than the payments of a bond.
D) All these are differences between stocks and bonds.
9) Which of the following is a characteristic of stock?
A) Stock represents a promise to repay a fixed amount of funds.
B) The face value or principal plus interest is repaid at a specified period of time.
C) The length of coupon payments is fixed by the stated maturity period.
D) Stock represents ownership in a firm
10) Payments by a corporation to its shareholders are known as
A) stocks.
B) bonds.
C) coupons.
D) dividends.
11) If a corporate bond with face value of $1,000 has an interest rate of eight percent paid once a
year for a term of 30 years, what is the size of the coupon payment?
A) $1,000
B) $300
C) $80
D) $8
12) If a corporate bond with a face value of $5,000 pays yearly coupon payments of $100, what
is the coupon rate?
A) 2%
B) 5%
C) 10%
D) 20%