Question 1

Agency theory is concerned with the problem that arises when it is difficult or inexpensive for the principal to verify what the agent is actually doing.

Accepted Answer

Agency theory is concerned with resolving two problems that can occur in agency relationships between two primary players. These are the principals, who are the owners of the firm (stockholders), and the agents, who are the people paid by principals to perform a job on their behalf (management). The first is the agency problem that arises (1) when the goals of the principals and agents conflict and (2) when it is difficult or expensive for the principal to verify what the agent is actually doing.

Question 2

Sound governance practices always leads to superior financial performance.

Accepted Answer

Sound governance practices often lead to superior financial performance. However, this is not always the case. For example, practices such as independent directors (directors who are not part of company management) and stock options are generally assumed to result in better performance. But in many cases, independent directors may not have the necessary expertise or involvement, and the granting of stock options to the CEO may lead to decisions and actions calculated to prop up share price only in the short term.

Question 3

Research has shown that executives who have large holdings of stock in their firm are more likely to have diversification strategies more consistent with shareholder interests, like increasing long-term returns.

Accepted Answer

Agents (executives) may have a stronger preference toward diversification than shareholders, because it reduces their personal level of risk from potential loss of employment. Executives who have large holdings of stock in their firms were more likely to have diversification strategies that were more consistent with shareholder interests, like increasing long-term returns.

Question 4

In order to have effective board operations, firms need to cultivate engaged and committed boards.

Accepted Answer

Research and simple observations of boards indicate that simple prescriptions, such as having a majority of outside directors, are insufficient to lead to effective board operations. Firms need to cultivate engaged and committed boards.

Question 5

The corporate governance premium is smaller for firms in countries with sound corporate governance practices compared to countries with weaker corporate governance standards.

Accepted Answer

The corporate governance premium is larger for firms in countries with sound corporate governance practices compared to countries with weaker corporate governance standards.

Question 6

Changes in board of director configurations since 1987 indicate that board directors were paid more in 2011, were older, were more often female, and were independent from the company (not insiders).

Accepted Answer

According to a Harvard Business Review article in 2011, the percentage of boards that had an average age of 64 or older increased; the average pay for directors increased; the percentage of board members who were female increased; the percentage of boards with 12 or fewer members increased; and the percentage of directors who were independent increased. These changes resulted from regulator and investor efforts in response to financial crises and corporate scandals.

Question 7

According to the Business Roundtable, representing the largest U.S. corporations, the most important quality of a good board of directors is that they do not get involved in critiquing company strategies.

Accepted Answer

According to the Business Roundtable, the most important quality for a good board of directors is to be active, critical participants in determining company strategies. That does not mean board members should micromanage or circumvent the CEO. Rather, they should provide strong oversight going beyond simply approving the plans of the CEO.

Question 8

The Sarbanes-Oxley Act of 2002 stipulates that executives of a firm will still be able to sell their shares in the firm when other employees cannot.

Accepted Answer

The failure of a variety of external control mechanisms led the U.S. Congress to pass the Sarbanes-Oxley Act in 2002. This act calls for many stringent measures that would ensure better governance of U.S. corporations. One of these measures is that executives must promptly reveal the sale of shares in firms they manage and are not allowed to sell when other employees cannot.

Question 9

Agency theory is concerned with the problem that arises when the goals of the agents conflict with those of the surrounding community members.

Accepted Answer

Agency theory is concerned with resolving two problems that can occur in agency relationships between two primary players. These are the principals, who are the owners of the firm (stockholders), and the agents, who are the people paid by principals to perform a job on their behalf (management). The first is the agency problem that arises (1) when the goals of the principals and agents conflict and (2) when it is difficult or expensive for the principal to verify what the agent is actually doing.

Question 10

The Sarbanes-Oxley Act of 2002 requires that CEOs and CFOs of publicly-listed companies must reveal off-balance-sheet finances and vouch for the accuracy of information provided.

Accepted Answer

The failure of a variety of external control mechanisms led the U.S. Congress to pass the Sarbanes-Oxley Act in 2002. This act calls for many stringent measures that would ensure better governance of U.S. corporations. One of these measures is that CEOs and CFOs must fully reveal off-balance-sheet finances and vouch for the accuracy of the information revealed.

Question 11

CalPERS, the California Public Employees Retirement System, manages over 240 billion dollars in assets. As an example of shared activism, they review all short- and long-term performance figures for each of the firms in which they invest and request changes in the governance structure of those firms, when they feel the firm is not responsive to their concerns.

Accepted Answer

Shareholder activism refers to actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization. Every year CalPERS reviews the performance of the 1,000 firms in which it retains a sizable investment. They review short- and long-term performance of each firm in its portfolio, its governance characteristics, its financial status, and market expectations for the firm. CalPERS then meets with selected companies to better understand their governance and business strategy. If needed, CalPERS requests changes in the governance structure of the firm and works to ensure shareholder rights.

Question 12

When firms like Siebel Systems, Disney, Oracle, and Microsoft separated the roles of CEO and chairman of the board, they were creating CEO duality.

Accepted Answer

CEO duality also serves to reinforce popular doubts about the legitimacy of the system as a whole and evokes images of bosses writing their own performance reviews and setting their own salaries. Firms like Siebel Systems, Disney, Oracle, and Microsoft have also decided to divide the roles between the CEO and chairman and eliminate duality.

Question 13

A corporation is a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. Management is able to participate in the profits of the enterprise without taking direct responsibility for the operations.

Accepted Answer

A corporation is a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. The shareholders (investors) are able to participate in the profits of the enterprise without taking direct responsibility for the operations. The management can run the company without the responsibility of personally providing the funds. The shareholders have limited liability as well as rather limited involvement in the company's affairs. However, they reserve the right to elect directors who have the fiduciary obligation to protect their interests.

Question 14

Principal-principal (PP) conflicts frequently result in expropriation, which is defined as activities to enrich minority shareholders to assure their support.

Accepted Answer

The result of PP conflict is often that family managers, who represent (or actually are) the controlling shareholders, engage in expropriation of minority shareholders, which is defined as activities that enrich the controlling shareholders at the expense of minority shareholders.

Question 15

Stock analysts generally issue more sell recommendations than buy recommendations.

Accepted Answer

It is generally observed that analyst recommendations are often more optimistic than warranted by facts. Sell recommendations tend to be exceptions rather than the norm. Part of the explanation may be that most analysts work for firms that also have investment banking relationships with companies they follow. Negative recommendations may cause them to take their investment banking business to a rival firm.

Question 16

Auditors are appointed by the Securities and Exchange Commission to audit company financial statements.

Accepted Answer

All accounting statements are required to be audited and certified to be accurate by external auditors. But auditors are appointed by the firm being audited. The desire to continue that business relationship sometimes makes them overlook financial irregularities.

Question 17

Public companies are required by law to disclose information regarding executive compensation packages.

Accepted Answer

All public corporations are required to disclose a substantial amount of financial information by bodies such as the Securities and Exchange Commission. These include quarterly and annual filings of financial performance, stock trading by insiders, and details of executive compensation packages.

Question 18

One of the most critical roles of the board of directors is to create incentives that align the interests of the CEO and top executives with the interests of shareholders.

Accepted Answer

Managerial incentives, sometimes called contract-based outcomes, consist of reward and compensation agreements for managers. Here the goal is to carefully craft managerial incentive packages to align the interests of management with those of the stockholders.

Question 19

In emerging economies and continental Europe, principal-principal conflicts are frequent. These consist of conflicts between controlling shareholders and executives.

Accepted Answer

In emerging economies and continental Europe there is often concentrated ownership, along with extensive family ownership and control, business group structures, and weak legal protection for minority shareholders. Serious conflicts tend to exist between two classes of principals: controlling shareholders and minority shareholders. Such conflicts can be called principal-principal (PP) conflicts.

Question 20

The risk of being acquired by hostile raiders is often referred to as the takeover constraint.

Accepted Answer

The risk of being acquired by a hostile raider is often referred to as the takeover constraint. The takeover constraint deters management from engaging in opportunistic behavior since the first thing that the raider may do on assuming control over the company is to fire the underperforming management.

Quiz 9: Strategic Control and Corporate Governance