Deck 18: Corporate Governance

Question 1

In 2003, Sony Corporation announced reform in its management structure. The reform included an increase in the number of outside directors on the Board of Directors, a requirement to separate the Chairman of the Board from the CEO, and greater inclusion of outside directors on the Nomination Committee. Analyze these changes from the perspective of separation of decision control from decision management.

Answer 1

Outside directors are only involved in decision control, unlike inside directors who are likely to serve both decision control and management functions. The inclusion of outside directors should improve decision control since there will be less capture by top management. Similarly, prohibiting the CEO from chairing the board reduces the amount of decision control authority vested in the CEO, who is also the principal manager with decision management rights. Finally, outside directors are more likely to nominate future board members who have no personal relationships with executives in the company - fewer favors traded between those having decision control and those having decision management.

Question 2

Board members act in the best interest of the firm:

A) because they are required to by law.
B) when they do not own stock in the firm.
C) when they take an extremely cautious approach to ratifying decisions.
D) in part because they wish to maintain a good reputation in order to be offered other board positions.

Answer 2

D

Question 3

Provide an economic critique of the statement "U.S. corporate governance is overly focused on shareholders at the expense of employees and other corporate stakeholders".

Answer 3

Models that focus on satisfying multiple stakeholders don't provide a clear weighting of employees and other corporate stakeholders. Satisfying these other stakeholders may come at the expense of shareholders, reducing the value of the firm and making it less competitive in the marketplace, thereby reducing profit. Proponents of the shareholder focused approach avoid this tradeoff. More efficient companies would be able to reward their employees based on their high productivity. More highly profitable companies will be more likely to survive and thus would be less likely to lay off employees. In addition, when shareholders reap greater rewards, they will be better able to satisfy their own altruistic preferences.

Question 4

What are the shareholder incentives within a corporation?

Question 5

Separation of ownership from control clearly expands the potential for principal/agent conflict. Why don't large corporations fail in large numbers because of this conflict?

Question 6

Bebchuk and Fried's managerial power theory states that:

A) the typical corporate board is not captured by managers.
B) all firms have about the same quality of governance.
C) product, labor, and takeover markets help limit executive pay but do not work perfectly.
D) managers want performance-based pay.

Question 7

The Wall Street Journal ("Boards Tie CEO Pay More Tightly to Performance," 2/21/06, p. A1) reports an increase in the number of major U.S. corporations that tie the CEO's stock options to performance targets. Comment on the wisdom of this trend, given the separation of ownership and control in U.S. corporations.

Question 8

The Sarbanes-Oxley Act of 2002 attempts to reduce corporate fraud among top-level executives. Comment on the strengths and weaknesses of this act.

Question 9

Blockholders:

A) participate more than small shareholders in the governance process because they internalize more of the benefits.
B) add value to the corporation when they extract private benefits.
C) are superior to institutional investors in their ability to reduce agency costs.
D) should not be managers of the firm.

Question 10

Adolph Berle and Gardiner Means argued that widely held corporations will be run inefficiently by professional managers. Yet large, publicly-traded corporations continue to produce the bulk of the free world's output. The widely held corporation survives because:

A) it can raise capital from diversified investors.
B) ownership and control are separated.
C) government taxes large corporations at low rates.
D) its size insulates it from market competition.

Question 11

"Corporate governance" refers to aspects of the corporation such as:

A) the corporate tax rate.
B) CEO compensation.
C) decentralization of decision rights to union workers.
D) government regulation of corporate health and safety.

Question 12

The specific structure of a U.S. corporation's charter and bylaws is constrained by:

A) the union's fiduciary responsibilities.
B) preferred stock holders.
C) Securities Exchange Commission regulations.
D) the focal point for a set of contracts.

Question 13

Adolph Berle and Gardiner Means argued that widely held corporations will be run inefficiently by professional managers. Their argument is based on:

A) inefficient product market structures
B) an inefficient market for CEOs
C) blockholders' control
D) incentive conflicts between shareholders and managers

Question 14

Advancement opportunities for high level executives through tournament-type processes ("horse races"):

A) motivate greater executive effort.
B) encourage cooperation among executives.
C) provide benefits that outweigh their incentive costs.
D) thwart innovative activities.

Question 15

For a large corporation, what does 'going private' mean? Why can't all corporations be privately held from a practical point of view?

Question 16

Shareholder voting rights should:

A) not be granted to management because of the agency problem.
B) be assigned only to small shareholders.
C) not be assigned to a founder who values control.
D) be assigned to those with residual-claim rights.

Question 17

What is managerial power theory and what are its implications?

Question 18

Explain how each of the following market forces helps reduce incentive conflicts between shareholders and management: a) the market for corporate control, b) the managerial labor market, and c) the product market.

Question 19

A closely held corporation is one that:

A) has all of its stock trade on the New York Stock Exchange.
B) uses bonds to raise most of its capital.
C) is free of all federal taxes and regulations.
D) is owned by a small group of investors that has limited or no publicly traded stock.

Question 20

A number of hospitals have converted from nonprofit to for-profit status. What are the benefits to this conversion? What impact might conversion to C corporation status have on hospital/community relations?

Question 21

The incentive problem within the modern corporation is that the:

A) decision makers have stronger incentives to use assets productively than in small business where there is big separation of ownership and control.
B) decision makers have weaker incentives to use assets productively than in small business where there is a big separation of ownership and control.
C) decision makers have stronger incentives to use assets productively than in small business where there is no separation of ownership and control.
D) decision makers have weaker incentives to use assets productively than in small business where there is no separation of ownership and control.

Question 22

Closely held corporations are characterized by:

A) a small number of shareholders each holding on to lots of shares for a long time.
B) a large number of shareholders each holding on to a few shares for a long time.
C) stock that is freely traded only among a few shareholders.
D) stock that is not freely traded and often held by a few shareholders.

Question 23

Based on a historical perspective, we can say that the architecture of:

A) publicly traded corporations will continue with their current state and become stagnant.
B) publicly traded corporations will become highly vulnerable to fraud and scandals.
C) publicly traded corporations will soon become too powerful and unmanageable.
D) publicly traded corporations will continue to evolve and change over time.

Question 24

The incentive problem within the modern corporation is that the:

A) corporate managers have stronger incentives to rather quickly transfer control of the firm to less informed management teams.
B) corporate managers have weaker incentives to transfer control of the firm to less informed management teams.
C) corporate managers have stronger incentives to rather quickly transfer control of the firm to more informed management teams.
D) corporate managers have weaker incentives to transfer control of the firm to more informed management teams.

Question 25

For-profit companies have the advantage of designing wealth-based incentives for executives and the:

A) ability to gain donations.
B) ability to raise equity capital.
C) legal right to borrow money.
D) right to provide medical services.

Question 26

The business organization that is individually owned and where ownership is connected with unlimited liability is the:

A) proprietorship.
B) limited liability partnership.
C) S corporation.
D) C corporation.

Question 27

Which one of the following is implicit in applying "Economic Darwinism"?

A) Because X has been here, X is best, and hence has been replaced by something else.
B) Because X has been here, X is best, but it should be replaced by something else.
C) Because X has been here, X is worst, and it should replaced by something else.
D) Because X has been here, X is best, else it would have been replaced by something else.

Question 28

A widely held corporation is one in which:

A) no one owner controls more than 5% of the shares.
B) no one owner controls more than 15% of the shares.
C) no one owner controls more than 20% of the shares.
D) no one owner controls more than 10% of the shares.

Question 29

The external control(s) to manage executive behavior are:

A) the market for lemons.
B) the managerial labor market.
C) the labor market.
D) the stock market.

Question 30

The large corporation generally has a separation of ownership from executive control. This can lead to:

A) reorganization as a proprietorship.
B) principal/agent problems.
C) harmony between principals and agents.
D) a partnership of principals.

Question 31

For the C corporation, the ownership of the residual profits is vested in the:

A) proprietor.
B) partner.
C) the top executives.
D) shareholders.

Question 32

Shareholders:

A) are the ultimate owners and have major decision authority in the management of the firm.
B) are not the ultimate owners, yet have major decision authority in the management of the firm.
C) are not the ultimate owners and have no major decision authority in the management of the firm.
D) are the ultimate owners but have no major decision authority in the management of the firm.

Question 33

The S corporation is:

A) identical to the C corporation.
B) identical to the proprietorship or the general partnership.
C) designed to provide limited liability to small closely-held companies.
D) too complex a business structure to be attractive to small businesses.

Question 34

In the United States, the Board of Directors of corporations have a fiduciary responsibility to:

A) price the products they produce.
B) raise investment capital in their spare time.
C) operate the company on a day-to-day basis.
D) represent the stockholders.

Question 35

Incorporation occurs:

A) initially at state and then at the federal level subject to state approval.
B) initially at federal and then at the state level subject to federal approval.
C) at the federal level only.
D) at the state level only.

Question 36

One the important advantages of the nonprofit organization is:

A) lower taxes.
B) ease of issuing new stock.
C) ability to pay top managers portions of the residual profit.
D) its universal use in the manufacturing sector.

Question 37

The business organization with the smallest amount of agency problems is the:

A) proprietorship.
B) general partnership.
C) S corporation.
D) C corporation.

Question 38

The lessons from Economic Darwinism are:

A) publicly held corporations have evolved unsuccessfully through the competitive process and are not going to be here to stay and flourish.
B) publicly held corporations have evolved successfully through the competitive process but they are not here to stay and flourish.
C) publicly held corporations have evolved unsuccessfully through the competitive process but will be here to stay and flourish.
D) publicly held corporations have evolved successfully through the competitive process and are here to stay and flourish.

Question 39

Corporate governance describes:

A) government control of the top management.
B) organizational architecture at the bottom-level of the organization.
C) organizational architecture at the middle-management level of the organization.
D) organizational architecture at the top of the organization.