Question 1

The name economists give the process by which stockholders gather information by frequent monitoring of the firm's activities is

Accepted Answer

The process described is known as costly state verification, where stockholders incur costs to gather information about the firm's activities. This helps to align the interests of stockholders and managers, as stockholders can monitor the actions of managers to ensure they are acting in the best interest of the firm. The other choices are not relevant to this process.

Question 2

The recent Enron and Tyco scandals are an example of

Accepted Answer

The Enron and Tyco scandals were driven by a principal-agent problem. The executives at Enron and Tyco were the agents, hired by the owners/shareholders as principals. Unfortunately, the incentives provided to the agents were misaligned with the interests of the principals, leading to fraudulent behavior and financial misstatements. The principals were therefore unable to fully monitor and control the actions of their agents, leading to significant harm to shareholders and the public.

Question 3

Managers (________)may act in their own interest rather than in the interest of the stockholder-owners (________)because the managers have less incentive to maximize profits than the stockholder-owners do.

Accepted Answer

The concept being described here is the principal-agent problem, where the stockholder-owners (principals) employ managers (agents) to run the company. However, the agents may act in their own interest rather than the interest of the principals, especially if the managers' incentives are not aligned with maximizing profits. Therefore, option D, agents-principals, correctly describes this relationship.

Question 4

In the United States,the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the

Accepted Answer

The Securities and Exchange Commission (SEC) is the government agency responsible for regulating the securities market in the United States. The SEC requires that firms selling securities in public markets adhere to standard accounting principles and disclose accurate and complete information about their sales, assets, and earnings to protect investors from fraud and misrepresentation. The Federal Communications Commission (FCC) regulates communication by radio, television, wire, satellite, and cable in the United States. The Federal Trade Commission (FTC) regulates business practices for the purpose of promoting fair competition and protecting consumers from deceptive and unfair practices. The Federal Reserve System is responsible for managing the monetary policy of the United States.

Question 5

The principal-agent problem

Accepted Answer

The principal-agent problem arises when there is a conflict of interest between the principal (owners or shareholders) and the agent (managers), often due to asymmetric information, where the agent has more information than the principal. If the owners had complete information about the managers' activities, this problem would not occur because they could perfectly monitor and ensure that managers act in the owners' best interests.

Question 6

The concept of adverse selection helps to explain

Accepted Answer

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the context of financial markets, this can lead to market failure as bad credit risks are more likely to seek loans than good credit risks, prompting lenders to protect themselves. This problem is a key reason financial markets are heavily regulated, to ensure information is disclosed and to protect against market failures caused by information asymmetries.

Question 7

As information technology improves,the lending role of financial institutions such as banks should ________.

Accepted Answer

As information technology improves, there is a rise in online lending platforms, peer-to-peer lending, and other alternative financing options. This reduces the dependency on traditional banks for borrowing, thereby decreasing their lending role.

Question 8

Analysis of adverse selection indicates that financial intermediaries,especially banks,

Accepted Answer

Adverse selection creates a free-rider problem for potential investors, and financial intermediaries like banks have an advantage in overcoming this problem by gathering information about clients and pooling risks. This helps to explain why indirect finance (where funds are mediated through financial intermediaries) is a more important source of business finance than direct finance (where funds are obtained directly from markets).

Question 9

The problem of adverse selection helps to explain

Accepted Answer

Adverse selection (the tendency of those with higher risk to be more likely to seek out and obtain loans) is a concern for lenders in securities markets, as they may end up with a portfolio of risky loans. Thus, firms may prefer to obtain funds from financial intermediaries who can screen borrowers for creditworthiness before lending them money.

Question 10

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

Accepted Answer

The answer of That most used cars are sold by...

Question 11

A problem for equity contracts is a particular type of ________ called the ________ problem.

Accepted Answer

The correct answer is moral hazard; principal-agent problem. This problem arises when there is a conflict of interest between a principal (e.g., a shareholder) and an agent (e.g., a company's executive), where the agent has an incentive to act in their own best interests rather than those of the principal, especially when the principal cannot perfectly monitor the agent's actions.

Question 12

The concept of adverse selection helps to explain all of the following except

Accepted Answer

Adverse selection explains why indirect finance is more important than direct finance as a source of business finance because lenders are better able to mitigate the risk of adverse selection through intermediaries. It also explains why firms are more likely to obtain funds from banks and other financial intermediaries. However, it does not explain why direct finance is more important than indirect finance or why the financial system is heavily regulated.

Question 13

That only large,well-established corporations have access to securities markets

Accepted Answer

If only large, well-established corporations have access to securities markets, it means that smaller and newer firms must rely on indirect finance, such as bank loans, to obtain external funds. This highlights the importance of indirect finance as a source of capital for small businesses.

Question 14

Net worth can perform a similar role to ________.

Accepted Answer

Net worth can serve as collateral for loans or other financial transactions.

Question 15

A lesson of the Enron collapse is that government regulation

Accepted Answer

The Enron collapse revealed the problem of asymmetric information between the firm's executives and shareholders/investors. Government regulation can reduce the degree of asymmetric information, but it cannot eliminate it entirely. Thus, option B is the best choice. Option A is incorrect because government regulation can be effective in some cases. Option C is incorrect because government regulation can reduce the degree of asymmetric information. Option D is incorrect because reducing government regulation may worsen the problem of asymmetric information.

Question 16

Equity contracts

Accepted Answer

Equity contracts represent ownership in a business and therefore entitle the holder to a share in the profits and assets of the business. Debt contracts, on the other hand, represent a creditor's claim on the assets and cash flows of the business. Option B is incorrect because equity contracts are subject to higher costly state verification than debt contracts. Option C is also incorrect because debt contracts are used more frequently to raise capital than equity contracts. Option D is incorrect because equity contracts, like all contracts, are subject to the moral hazard problem.

Question 17

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

Accepted Answer

The principal-agent problem refers to the situation where an agent (in this case, the manager of the firm) may not act in the best interests of the principal (the stockholders) because they have different incentives. In the case of equity contracts, the manager may not have as strong of an incentive to maximize profits as the stockholders would ideally prefer, as they do not necessarily benefit as directly from the success of the firm. This creates a moral hazard problem. Adverse selection refers to the issue of lack of information in insurance markets, free-rider refers to people benefiting from a public good without contributing to its production, and debt deflation refers to a situation where a decrease in prices leads to an increase in the real value of a debtor's obligations, which can create problems for the economy as a whole.

Question 18

How does collateral help to reduce the adverse selection problem in credit market?

Accepted Answer

The answer of How does collateral help to reduce the...

Question 19

Government regulations require publicly traded firms to provide information,reducing

Accepted Answer

Government regulations requiring publicly traded firms to provide information helps to reduce the adverse selection problem by providing potential investors with necessary information to make informed decisions, thus reducing the risk of choosing investments with negative outcomes. Information disclosure can increase transparency and reduce information asymmetry, ultimately leading to the more efficient allocation of resources.

Question 20

Because of the adverse selection problem,

Accepted Answer

The answer of Because of the adverse selection problem,
...

Quiz 8: An Economic Analysis of Financial Structure

The name economists give the process by which stockholders gather information by frequent monitoring of the firm's activities is

The recent Enron and Tyco scandals are an example of

Managers () may act in their own interest rather than in the interest of the stockholder-owners () because the managers have less incentive to maximize profits than the stockholder-owners do.

In the United States,the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the

The principal-agent problem

The concept of adverse selection helps to explain

As information technology improves,the lending role of financial institutions such as banks should ________.

Analysis of adverse selection indicates that financial intermediaries,especially banks,

The problem of adverse selection helps to explain

That most used cars are sold by intermediaries (i.e.,used car dealers) provides evidence that these intermediaries

A problem for equity contracts is a particular type of called the problem.

The concept of adverse selection helps to explain all of the following except

That only large,well-established corporations have access to securities markets

Net worth can perform a similar role to ________.

A lesson of the Enron collapse is that government regulation

Equity contracts

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

How does collateral help to reduce the adverse selection problem in credit market?

Government regulations require publicly traded firms to provide information,reducing

Because of the adverse selection problem,

Quiz 8: An Economic Analysis of Financial Structure

The name economists give the process by which stockholders gather information by frequent monitoring of the firm's activities is

The recent Enron and Tyco scandals are an example of

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

In the United States,the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the

The principal-agent problem

The concept of adverse selection helps to explain

As information technology improves,the lending role of financial institutions such as banks should ________.

Analysis of adverse selection indicates that financial intermediaries,especially banks,

The problem of adverse selection helps to explain

That most used cars are sold by intermediaries (i.e.,used car dealers) provides evidence that these intermediaries

A problem for equity contracts is a particular type of ________ called the ________ problem.

The concept of adverse selection helps to explain all of the following except

That only large,well-established corporations have access to securities markets

Net worth can perform a similar role to ________.

A lesson of the Enron collapse is that government regulation

Equity contracts

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

How does collateral help to reduce the adverse selection problem in credit market?

Government regulations require publicly traded firms to provide information,reducing

Because of the adverse selection problem,

Managers () may act in their own interest rather than in the interest of the stockholder-owners () because the managers have less incentive to maximize profits than the stockholder-owners do.

A problem for equity contracts is a particular type of called the problem.