Exam 12: Agency Problems, Compensation, and Performance Measurement

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

Shareholders typically rely on independent auditors to monitor the performance of their managers.

Which of the following actions-all else equal-will increase a firm's EVA?

The following are advantages of using EVA as a performance measure EXCEPT:

Which of the following actions-all else equal-will decrease a firm's EVA?

According to the survey of senior managers by Graham,Harvey,and Rajgopal,senior managers admitted to the following: I.adjusting their firms' operations and investments in order to manage earnings; II.decreasing discretionary spending in R&D,advertising,or maintenance to meet earnings targets; III.deferring or rejecting investment projects with positive NPVs in order to meet earnings targets

CEOs of U.S.companies receive the highest level of compensation in terms of long-term incentives and variable bonuses.

Define the term economic income.

A firm has an average investment of $10,000 during the year.During the same time,the firm generates after-tax income of $2,000. Calculate the economic value added (EVA)for the firm.(The cost of capital is 15%.)

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

Boards of directors outside the U.S.are generally friendlier towards their own managers.

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

Economic income = cash flow - economic depreciation.

EVA = income earned - (cost of capital)× (investment).

All else equal,one would expect to see more earnings management at privately held corporations than at publicly traded corporations.

An example of an entrenching investment is a manager that expands the scope of his or her operation.

A firm produces $124 million of net income on $1,600 million of assets.Through a six-sigma project,the firm is able to decrease the assets employed to $1,450 million.Given a 5% cost of capital,what is the increase in the EVA?

Economic profit = EP = (ROI - r)(capital invested).

It is easy to apply EVA to R&D programs and start-up ventures.

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