978-1259717789 Chapter 4

CHAPTER 4 CORPORATE GOVERNANCE AROUND THE WORLD

SUGGESTED ANSWERS TO END–OF-CHAPTERQUESTIONS AND PROBLEMS

Questions

1. The majority of major corporations are franchised as public corporations. Discuss the key

strength and weakness of the ‘public corporation’. When do you think the public corporation

as an organizational form is unsuitable?

Answer: The key strength of the public corporation lies in that it allows for efficient risk sharing

among investors. As a result, the public corporation may raise a large sum of capital at a

2. The public corporation is owned by multitude of shareholders but managed by professional

managers. Managers can take self-interested actions at the expense of shareholders.

Discuss the conditions under which the so-called agency problem arises.

3. Following corporate scandals and failures in the U.S. and abroad, there is a growing

demand for corporate governance reform. What should be the key objectives of

corporate governance reform? What kind of obstacles can there be thwarting reform

efforts?

4. Studies show that the legal protection of shareholder rights varies a great deal across

countries. Discuss the possible reasons why the English common law tradition

provides the strongest and the French civil law tradition the weakest protection of

investors.

5. Explain ‘the wedge’ between the control and cash flow rights and discuss its implications for

corporate governance.

Answer: When there is a separation of ownership and control, managers have control rights with

insignificant cash flow rights, whereas shareholders have cash flow rights but no control rights.

6. Discuss different ways that dominant investors use to establish and maintain the control of

the company with relatively small investments.

7. The Cadbury Code of the Best Practice adopted in the United Kingdom led to a successful

reform of corporate governance in the country. Explain the key requirements of the Code

and discuss how it may have contributed to the success of reform.

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board structure helped to strengthen the monitoring function of the board and reduce the

agency problem.

8. Many companies grant stocks or stock options to the managers. Discuss the benefits

and possible costs of using this kind of incentive compensation scheme.

manipulate financial statements so that they can maximize their benefits in the short run.

9. It has been shown that foreign companies listed in the U.S. stock exchanges are valued

more than those from the same countries that are not listed in the U.S. Explain the reasons

why U.S.-listed foreign firms are valued more than those which are not. Also explain why not

every foreign firm wants to list stocks in the United States.

Answer: Foreign companies domiciled in countries with weak investor protection can bond

themselves credibly to better investor protection by listing their stocks in U.S. exchanges that

10. Explain “free cash flows.” Why do managers like to retain free cash flows instead of

distributing it to shareholders? Discuss what mechanisms may be used to solve this

problem?

Answer: Free cash flow represents a firm’s internally generated fund in excess of the amount

11. Epic bribe scandal at Petrobras, a major oil company controlled by the Brazilian

government, that broke out in 2015 shocked the economic and political system of Brazil. Put

simply, the company insiders, outside suppliers and contractors, and politicians colluded and

stole billions of dollars from the company via kickbacks, bid riggings, overcharging for

construction projects, etc. The Petrobras scandal led to a sharp drop of the company share

price, laying off thousands of workers, and tilting the national economy toward recession.

The scandal also seriously tarnished the image of Brazil as one of the promising emerging

markets. Document in detail what happened at Petrobras and then investigate how the

company’s governance and the country’s political culture may have contributed to the

scandal.

Answer: According to the 2015 Corruption Perceptions Index compiled by Transparency

International, a global civil organization, Brazil ranks 76th in the world below countries like

MINI CASE: Parmalat: Europe’s Enron

Discussion points.

1. How was it possible for Parmalat managers to “cook the books” and hide it for so long?

2. Investigate and discuss the role that international banks and auditors might have played

in Parmalat’s collapse.

3. Study and discuss Italy’s corporate governance regime and its role in the failure of

Parmalat.