Question 1

Which of the following is true regarding leveraged buy-outs (LBOs)?

Accepted Answer

Leveraged buy-outs (LBOs) involve managers or buyout partners acquiring controlling interests in public companies, usually financed by heavy borrowing. This creates a concentrated ownership structure and a high level of debt, which can help solve the agency problem by aligning the interests of managers and shareholders. Therefore, both options A and B are true regarding LBOs. Option C is incorrect as LBOs are not primarily focused on improving a company's free cash flow, but rather on restructuring its capital and ownership structure.

Question 2

Suppose in order to defraud the shareholders, a manager sets up an independent company that he owns sells the main company's output to this company. He would be tempted to set the transfer price

Accepted Answer

By setting the transfer price below market prices, the manager can benefit the independent company he owns by purchasing the main company's output at a lower cost, potentially increasing his personal profits at the expense of the main company's shareholders.

Question 3

The agency problem tends

Accepted Answer

The agency problem is more serious in firms with free cash flows and excessive cash because managers might misuse these resources. It is less serious in firms with fewer shareholders as monitoring is easier.

Question 4

Suppose in order to defraud the shareholders, a manager sets up an independent company that he owns buys one of the main company's inputs of production from this company. He would be tempted to set the transfer price

Accepted Answer

The manager would be tempted to set the transfer price above market prices in order to increase the profits of his independent company and ultimately defraud the shareholders of the main company. This would result in the main company paying more for the input of production than they would if they had purchased it from a different supplier at market prices.

Question 5

Outside the United States and the United Kingdom,

Accepted Answer

In many countries outside the United States and the United Kingdom, diffused ownership of the company is more prevalent, meaning that ownership is spread out among multiple shareholders rather than being concentrated in the hands of a few. This can lead to challenges in decision-making and corporate governance. Partnerships are also important in some countries, but not necessarily more so than corporations. Therefore, choices A and C are incorrect.

Question 6

Tobin's Q is

Accepted Answer

Tobin's Q is the ratio of the market value of company assets to the replacement costs of the assets. It is not a means to find overvalued stocks (option B) as a high Q value implies that the market value of the firm's assets is greater than the cost to replace those assets. Tobin's Q is also not the same as price-to-book ratio (option C). Therefore, option A is the correct choice.

Question 7

In the graph at right, X, Y, and Z represent

Accepted Answer

The answer of In the graph at right, X, Y,...

Question 8

Why do managers tend to retain free cash flow?

Accepted Answer

Managers may retain free cash flow for reasons that do not align with shareholders' best interests, such as empire building or personal incentives.

Question 9

Self-interested managers may be tempted to

Accepted Answer

All of the above options are potential abuses that self-interested managers may be tempted to enact on shareholders. Managers who are solely focused on their own interests may engage in actions that benefit themselves at the expense of shareholders, such as expensive perquisites or wasteful projects. They may also adopt anti-takeover measures to ensure their personal job security, even if such measures are not in the best interest of the company's long-term success.

Question 10

A complete contract between shareholders and managers

Accepted Answer

A complete contract would indeed specify actions for all contingencies, be costly to write and monitor, and eliminate conflicts of interest by removing managerial discretion.

Question 11

In high-growth industries where companies' internally generated funds fall short of profitable investment opportunities,

Accepted Answer

The answer of In high-growth industries where companies' internally generated...

Question 12

Why is it rational to make shareholders "weak" by giving control to the managers of the firm?

Accepted Answer

All of the given options provide a rationale for the separation of ownership and control, and why it may be rational for shareholders to give control to the managers of the firm. Shareholders may not have the requisite skills or expertise to make business decisions (option A), or may find it easier to sell their shares than to monitor the management (option B). Additionally, managers are accountable to the board of directors, which can act as a check on their decision-making (option C).

Question 13

The investors supply funds to the company but are not involved in the company's daily decision making. As a result, many public companies come to have

Accepted Answer

When investors supply funds but do not involve themselves in daily decision-making, it typically results in a scenario where the management has more control over the company's operations, leading to strong managers and weak shareholders. This is because the shareholders' lack of involvement in daily decisions diminishes their influence over the company's strategic direction.

Question 14

In the graph at right, for Fortune 500 companies, X, Y are

Accepted Answer

The answer of In the graph at right, for Fortune...

Question 15

It is important for society as a whole to solve the agency problem, since the agency problem

Accepted Answer

The agency problem leads to a variety of negative effects, including the waste of scarce resources (as managers may prioritize their own interests over those of shareholders), the hampering of capital market functions (as investors may be hesitant to invest if they don't trust that managers are acting in their best interests), and the retardation of economic growth (as companies may not be operating as efficiently or effectively as they could be). Therefore, solving the agency problem is important for society as a whole to maximize resource use, encourage investment, and promote economic growth.

Question 16

In the U.S., the chief role of the board of directors is

Accepted Answer

The chief role of the board of directors in the U.S. is to hire the management team. This is because the board of directors is responsible for overseeing the company and ensuring that it is managed in the best interests of the shareholders. One of the key ways that the board can do this is by hiring a competent and effective management team to run the day-to-day operations of the company. While the board may also be involved in decisions related to capital budgeting and compensation, hiring the management team is generally considered to be their most important responsibility.

Question 17

Managerial entrenchment efforts are clear signs of the agency problem. They include

Accepted Answer

Managerial entrenchment efforts refer to actions taken by managers to protect their positions and power, often at the expense of shareholders' interests. Anti-takeover defenses, poison pills, and changes in voting procedures are all examples of such efforts. Therefore, the best answer is D, all of the above.

Question 18

The agency problem refers to the possible conflicts of interest between

Accepted Answer

The agency problem arises due to potential conflicts of interest between self-interested managers who act as agents for the firm and shareholders who are the principals. Since managers can pursue their own interests, there is a risk that they may not act in the best interests of the shareholders or the firm. Therefore, shareholders need to design compensation packages and monitoring systems that align the interests of the managers with their own interests.

Question 19

Free cash flow refers to

Accepted Answer

Free cash flow refers to the cash generated by a company that is available for distribution among its investors or for reinvestment in the company's future growth, after the necessary capital expenditures have been made. It represents the cash that remains after the company has paid for all of its operating expenses, taxes, and capital expenditures, and is used to pay dividends, buy back stock, pay down debt, or invest in growth opportunities. Therefore, option B is the correct definition of free cash flow.

Question 20

In the United Kingdom, the majority of public companies

Accepted Answer

The Code of Best Practice on corporate governance in the UK does not have the force of law behind it. Public companies in the UK are not required by law to abide by the code, but many choose to do so voluntarily as a best practice for good governance. Therefore, the majority of public companies in the UK voluntarily abide by the Code of Best Practice on corporate governance.

Quiz 4: Corporate Governance Around the World

Which of the following is true regarding leveraged buy-outs (LBOs) ?