Question 1

Generally,firms should attempt to base mangers' compensation on:

Accepted Answer

Basing manager's compensation on verifiable results aligns their incentives with the success of the firm, encouraging them to work towards achieving the goals and objectives set by the organization. Alternatively, paying managers based on the number of years of managerial experience or the number of hours they work does not necessarily indicate the value they bring to the firm, nor does it motivate them to strive for better performance. Perks consumed are irrelevant to a manager's performance or contributions to the firm and should not factor into their compensation.

Question 2

The following actions by managers are examples of overinvestment:
i.entrenching investments; II)empire building; III)investing beyond the point where NPV falls to zero

Accepted Answer

Entrenching investments refer to investments that are difficult to reverse or difficult to liquidate, which makes it an example of overinvestment. Empire building refers to managers expanding the size of their company to increase their power and prestige, which can lead to overinvestment. Investing beyond the point where NPV falls to zero means that no further value is being generated, yet money is still being spent, leading to overinvestment. Therefore, all three actions are examples of overinvestment, making option D the correct choice.

Question 3

Since monitoring is not perfect,compensation plans should primarily provide managers incentives to:

Accepted Answer

Since monitoring is not perfect, compensation plans should provide incentives for managers to take actions that will maximize the value of the firm to the shareholders. This provides motivation for managers to act in the best interest of the company and its shareholders, even when there is less monitoring or oversight. Choices A, B, and C do not necessarily align with the goal of maximizing shareholder value.

Question 4

The following are agency problems associated with capital budgeting:
I.reduced effort
II.perks or private benefits
III.empire building
IV.entrenching investments
V.avoiding risks

Accepted Answer

All listed items (I, II, III, IV, and V) are agency problems in capital budgeting, as they represent conflicts of interest between managers and shareholders, where managers may act in their own interest rather than maximizing shareholder value.

Question 5

Which of the following capital expenditures may not appear in a firm's capital budget?
i.investment in a new factory; II)investment in a new machine; III)investment in training employees

Accepted Answer

While investments in a new factory and a new machine are typical capital expenditures that would appear in a firm's capital budget, investment in employee training may not be classified as a capital expenditure but rather an operating expense. Therefore, option C)III only is the best choice.

Question 6

Agency costs can be reduced by:
i.monitoring managers' efforts; II)monitoring managers' actions; III)intervening when managers veer off-course

Accepted Answer

All three options listed (monitoring managers' efforts, monitoring managers' actions, and intervening when managers veer off-course) are effective ways to reduce agency costs. By monitoring their efforts and actions, managers are more likely to stay on track and remain accountable. However, if they do veer off course, it is important to intervene in order to bring them back in line and prevent further losses due to agency costs. Therefore, options I, II, and III are all necessary for reducing agency costs.

Question 7

When firms award stock options to managers as incentives,they typically set the exercise price of these options equal to the firm's:

Accepted Answer

The exercise price of stock options is typically set equal to the stock price on the day the options are granted. This is known as the grant date fair value. The idea behind this is to align the interests of the managers with those of the shareholders, as the managers will only profit if the stock price increases above the exercise price. Setting the exercise price at the current stock price also prevents the managers from realizing a profit simply due to an expected increase in the stock price, which may or may not happen.

Question 8

The following capital expenditures are typically included in a firm's capital budget:

Accepted Answer

The answer of The following capital expenditures are typically included...

Question 9

The following are agency problems in capital budgeting except:

Accepted Answer

The answer of The following are agency problems in capital...

Question 10

In the principal-agent framework,the ultimate principals are:
i.managers; II)board of directors; III)shareholders; IV)governments

Accepted Answer

In the principal-agent framework, the ultimate principals are those who provide the capital to an organization, and in most cases, this refers to the shareholders. Therefore, the correct choice is III only. Managers and the board of directors may act as agents on behalf of the shareholders, while the government may have a regulatory or oversight role, but they are not ultimate principals.

Question 11

In large public companies monitoring is the primary responsibility of the:
i.shareholders; II)board of directors; III)independent accountants; IV)lenders

Accepted Answer

In large public companies, the primary responsibility of monitoring lies with the board of directors, who are elected by the shareholders to oversee the management of the company. Independent accountants and lenders may also have some monitoring responsibilities, but they are secondary to the board of directors. Shareholders have the right to vote on important issues and elect the board of directors, but they do not have direct monitoring responsibilities. Therefore, the best choice is II only.

Question 12

A firm has an average investment of $1,000 during the year.During the same time,the firm generates after-tax earnings of $150.
If the cost of capital is 10%,what is the net return on investment?

Accepted Answer

The net return on investment is calculated as (After-tax earnings - Cost of capital) / Average investment. Here, the cost of capital is $100 (10% of $1,000), so the net return is ($150 - $100) / $1,000 = 5%.

Question 13

Monitoring is typically done by:
i.shareholders; II)board of directors; III)independent accountants; IV)lenders

Accepted Answer

Monitoring is typically done by shareholders, the board of directors, independent accountants, and lenders, as they all have vested interests in the performance and governance of a company.

Question 14

CEO compensation is generally highest in (the):

Accepted Answer

CEO compensation in the U.S. is generally the highest when compared to other countries. According to a study by the Economic Policy Institute, the average CEO in the U.S. earns 320 times as much as the average worker, whereas in the U.K., the ratio is 201:1, and in Germany, it is 147:1. India does not have a standardized way of reporting CEO compensation, making it difficult to compare.

Question 15

The following are agency problems associated with capital budgeting except:

Accepted Answer

The other choices (A, C, and D) are all agency problems that can arise in capital budgeting. Reduced effort occurs when managers do not put forth their best effort to identify profitable projects or to ensure that projects are implemented efficiently. Empire building occurs when managers pursue projects that increase the size or power of their department or division, even if those projects do not maximize firm value. Perks are benefits that managers may seek to obtain from projects that do not necessarily contribute to the firm's bottom line. Maximizing firm value, however, is the primary goal of capital budgeting and not an agency problem.

Question 16

The free-rider problem,when referring to monitoring of the firms' performance,often results in:
I.ineffective monitoring by the shareholders;
II.monitoring being delegated by shareholders to boards of directors;
III.no monitoring by a large number of small individual investors

Accepted Answer

The free-rider problem affects all types of shareholders, resulting in ineffective monitoring by all shareholders, including small individual investors, who may not see the benefit of monitoring due to their small shareholding. As a result, monitoring is often delegated to boards of directors, who may not always act in the best interest of shareholders. Therefore, all options I, II, and III are correct.

Question 17

Managers on a fixed salary often fall victim to the following temptations:
i.reduced effort; II)needless spending on perks or private benefits; III)empire building; IV)entrenching investments; V)avoiding risks

Accepted Answer

Managers on a fixed salary may reduce effort due to lack of performance incentives, spend on perks for personal gain, engage in empire building to increase their power, make entrenching investments to secure their position, and avoid risks to maintain job security.

Question 18

Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers:
i.reduced effort; II)perks or private benefits; III)empire building; IV)entrenching investments; V)avoiding risks

Accepted Answer

Agency costs arise from conflicts of interest between managers and shareholders, leading to reduced effort, perks, empire building, entrenching investments, and risk avoidance, all of which can decrease firm value.

Question 19

The ultimate responsibility for monitoring a firm rests with the:
i.shareholders; II)board of directors; III)independent accountants; IV)lenders

Accepted Answer

The answer of The ultimate responsibility for monitoring a firm...

Question 20

A firm has an average investment of $1,000 during the year.During the same time,the firm generates after-tax earnings of $150.
Calculate the economic value added (EVA)for the firm.(The cost of capital is 10%.)

Accepted Answer

EVA is calculated as Net Operating Profit After Taxes (NOPAT) minus the product of the cost of capital and the average investment. Here, EVA = $150 - (10% of $1,000) = $150 - $100 = $50.

Quiz 12: Agency Problems, Compensation, and Performance Measurement

Generally,firms should attempt to base mangers' compensation on:

The following actions by managers are examples of overinvestment: i.entrenching investments; II) empire building; III) investing beyond the point where NPV falls to zero

Since monitoring is not perfect,compensation plans should primarily provide managers incentives to:

The following are agency problems associated with capital budgeting: I.reduced effort II.perks or private benefits III.empire building IV.entrenching investments V.avoiding risks

Which of the following capital expenditures may not appear in a firm's capital budget? i.investment in a new factory; II) investment in a new machine; III) investment in training employees

Agency costs can be reduced by: i.monitoring managers' efforts; II) monitoring managers' actions; III) intervening when managers veer off-course

When firms award stock options to managers as incentives,they typically set the exercise price of these options equal to the firm's:

The following capital expenditures are typically included in a firm's capital budget:

The following are agency problems in capital budgeting except:

In the principal-agent framework,the ultimate principals are: i.managers; II) board of directors; III) shareholders; IV) governments

In large public companies monitoring is the primary responsibility of the: i.shareholders; II) board of directors; III) independent accountants; IV) lenders

A firm has an average investment of $1,000 during the year.During the same time,the firm generates after-tax earnings of $150. If the cost of capital is 10%,what is the net return on investment?

Monitoring is typically done by: i.shareholders; II) board of directors; III) independent accountants; IV) lenders

CEO compensation is generally highest in (the) :

The following are agency problems associated with capital budgeting except:

The free-rider problem,when referring to monitoring of the firms' performance,often results in: I.ineffective monitoring by the shareholders; II.monitoring being delegated by shareholders to boards of directors; III.no monitoring by a large number of small individual investors

Managers on a fixed salary often fall victim to the following temptations: i.reduced effort; II) needless spending on perks or private benefits; III) empire building; IV) entrenching investments; V) avoiding risks

Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers: i.reduced effort; II) perks or private benefits; III) empire building; IV) entrenching investments; V) avoiding risks

The ultimate responsibility for monitoring a firm rests with the: i.shareholders; II) board of directors; III) independent accountants; IV) lenders

A firm has an average investment of $1,000 during the year.During the same time,the firm generates after-tax earnings of $150. Calculate the economic value added (EVA) for the firm.(The cost of capital is 10%.)