Deck 18: Organization Structure and Corporate Governance

Question 1

The merger between J.P. Morgan and Chase Manhattan banks that created JPMorgan Chase & Co. was a:

A) market extension merger.
B) conglomerate merger.
C) horizontal merger.
D) vertical merger.

Answer 1

C

Question 2

A business connection between companies at different points in the production-distribution chain is called a:

A) market extension merger.
B) vertical relation.
C) conglomerate merger
D) horizontal relation.

Answer 2

B

Question 3

The merger between Proctor & Gamble, maker of products like Tide, Crest, and Pampers, and Gillette, the Boston-based maker of razors and batteries, was a:

A) market extension merger.
B) conglomerate merger.
C) horizontal merger.
D) vertical merger.

Answer 3

B

Question 4

The quality-control potential of high-tech firms tends to result in:

A) low institutional ownership.
B) high inside ownership.
C) high institutional ownership.
D) significant financial leverage.

Question 5

Bank debt financing has control implications most similar to:

A) institutional equity.
B) inside equity.
C) outside equity.
D) none of these.

Question 6

The natural conflict between owners and managers is called the:

A) end-of game problem.
B) incentive problem.
C) agency problem.
D) capture problem.

Question 7

Union organizing expenses are a type of:

A) information cost.
B) search expense.
C) enforcement cost.
D) decision cost.

Question 8

The inefficient preference for stable performance is called the:

A) information asymmetry problem.
B) information sharing problem.
C) managerial myopia problem.
D) stockholder myopia problem.

Question 9

Enforcement costs are:

A) coordination expenses.
B) search outlays.
C) information costs.
D) charges tied to contractual commitments.

Question 10

The managerial myopia problem:

A) causes excessive risk-taking.
B) is caused by excessive risk-taking.
C) is reflected in a managerial preference for short-term performance
D) is the tendency by agents to be careless with the principal's resources.

Question 11

A franchise agreement is:

A) a formal contractual arrangement specifying a parent-subsidiary relationship.
B) an informal voluntary arrangement specifying a parent-subsidiary relationship.
C) between independent sub-units of a single corporation with decision-making authority.
D) a control system that helps corporations effectively manage, administer and direct economic resources within the firm.

Question 12

A reasonable before-the-fact forecast of monetary implications describes:

A) monetary outcomes.
B) financial outcomes.
C) economic expectations.
D) economic realizations.

Question 13

A vertical organization has:

A) one level of decision authority.
B) few levels of decision authority.
C) none of these.
D) multiple levels of decision authority.

Question 14

Rate of return regulation tends to reduce:

A) inside ownership.
B) institutional ownership.
C) outside ownership.
D) none of these.

Question 15

The Coase Theorem argues that resource allocation is:

A) inefficient if transaction costs are low and property rights are freely traded.
B) inefficient if transaction costs are low.
C) inefficient if property rights are freely traded.
D) efficient if transaction costs are low and property rights are freely traded.

Question 16

High inside ownership at Microsoft reflects the company's:

A) low amenity potential.
B) low quality-control potential.
C) regulatory potential.
D) high quality-control potential.

Question 17

The reservation wage includes a return to:

A) risk-avoidance behavior.
B) special capabilities within the firm.
C) firm-specific human capital.
D) general human capital.

Question 18

Expenditures necessary to overcome owner-manager conflicts are called:

A) decision costs.
B) search costs.
C) information costs.
D) agency costs.

Question 19

A "flat" organization design reflects a:

A) "close-to-the-customer" management style.
B) U-form organization.
C) centralized decision authority.
D) "top-down" management style.

Question 20

Ownership value derived from the ability to control the type of output produced gives rise to high:

A) debt levels.
B) ownership dispersion.
C) institutional ownership.
D) inside ownership.

Question 21

Horizontal and Vertical Relations. Dell Computer Corp. designs, develops, manufactures, markets, services and supports a wide range of computer systems, including desktops, notebooks and network servers, and also markets software, peripherals and service and support programs. They are the world's leading direct computer systems company and one of the top five computer vendors in the world. Compaq Computer Corp. designs, develops, manufactures, and markets a wide range of personal computing products, including desktop personal computers, portable computers, PC servers and peripheral products that store and manage data in network environments. The company markets its products primarily to business, home, government, and education customers. Compaq operates in one principal industry segment across geographically diverse markets.
A. Do Dell and Compaq share important elements of a vertical relationship? If so, how?
B. Do Dell and Compaq share important elements of a horizontal relationship? If so, how?

Question 22

The fiduciary responsibility of institutional investors can cause mutual funds to act like:

A) debt financing.
B) outside equity.
C) inside equity.
D) none of these.

Question 23

Horizontal and Vertical Relations. Intel Corp. designs, manufactures and markets microcomputer components and related products at various levels of integration. Intel's principal components consist of silicon-based semiconductors etched with complex patterns of transistors. Microsoft Corp. develops, manufactures, licenses and supports a range of software products, including scalable operating systems, server applications, business and consumer productivity applications, software development tools and Internet software and technologies. Together, Intel and Microsoft Corp. are sometimes described as comprising the "Wintel" monopoly.
A. Describe how Intel and Microsoft share important elements of a vertical relationship.
B. Describe how Intel and Microsoft have important elements of a horizontal relationship.

Question 24

The Sarbanes-Oxley Act does not significantly tighten accountability standards for:

A) directors and officers.
B) stockholders.
C) auditors and legal counsel.
D) security analysts.

Question 25

Horizontal and Vertical Relations. Barnes & Noble, Inc. is one of the world's largest booksellers. The company's principal business is the retail sale of trade books, generally hardcover and paperback consumer titles, excluding educational textbooks and specialized religious titles, mass market paperbacks, such as mystery, romance, science fiction and other popular fiction, children's books, off-price bargain books and magazines. Borders Group, Inc. is one of the largest operators of book superstores and mall-based bookstores in the world based upon both sales and number of stores. Borders is a premier operator of book and music superstores, offering customers selection and service that the company believes to be superior to other book superstore operators. Each Borders superstore offers customers a vast assortment of books, customer service, value pricing and an inviting and comfortable environment designed to encourage browsing.
A. Do Barnes & Noble and Borders share important elements of a vertical relationship? If so, how?
B. Do Barnes & Noble and Borders share important elements of a horizontal relationship? If so, how?

Question 26

Transactions Costs. Humana, Inc., offers managed health care products which integrate management with the delivery of health care services through a network of providers, who in their delivery of quality medical services, may share financial risk or who have incentives to deliver cost-effective medical services. It also offers administrative services products including group life, dental, disability income, workers' compensation, and pharmacy management services.
A. Use transactions costs to explain the existence of HMOs like Humana.
B. When will less formal contracting arrangements supplant the need for a formal corporate structure?

Question 27

Coase Theorem. One of the traditional arguments in favor of government intervention in the market economy is that unregulated market activity can sometimes lead to failures, like pollution. Critics of government failures to deal with pollution problems effectively argue that there exist private-market solutions to the pollution problem.
A. What is the Coase Theorem?
B. Use the Coase Theorem to explain how the private sector might efficiently deal with pollution problems.

Question 28

Agency Problem. In 2005, Qwest Communications International Inc. ended its pursuit of MCI Inc. While the Denver-based company had worked hard to win Virginia-based MCI, Qwest walk away from a bidding war with Verizon Communications Inc., a large New York-based phone company, when Qwest's increasingly expensive effort seemed futile. Ending a furious three-month bidding war, long-distance phone titan MCI turned down a $9.74 billion takeover offer from Qwest, a local and long-distance phone company, in favor of a $8.44 billion offer from the more financially secure Verizon. At the time, some of MCI's largest shareholders criticized MCI's board for taking the lower bid and urged Qwest to persist, but Qwest declined.
A. What is the potential agency problem at Qwest?
B. What is the source of agency problems within Qwest and similar companies?

Question 29

The relationship between McDonalds and Coca-Cola is:

A) vertical.
B) virtual.
C) conglomerate.
D) horizontal.

Question 30

The emerging business use of the Internet increases:

A) transaction costs.
B) search costs.
C) enforcement costs.
D) none of these.

Question 31

Virtual Corporation. The Walt Disney Company is a diversified, international family entertainment and media juggernaut whose operations include world-famous theme parks and resorts. The company also includes a filmed entertainment division, specializing in motion pictures and television shows, and home video products. Disney also offers records, consumer products, a cruise line, radio and television stations, broadcast and cable networks, publishing activities and professional sports enterprises.
A. What is the Coase Theorem?
B. Use the Coase Theorem to explain Disney's long-term success.

Question 32

Horizontal and Vertical Relations. America Online, Inc., is a provider of online services to consumers in the United States. AOL offers subscribers a wide variety of services, including electronic mail, conferencing, news, sports, weather, stock quotes, software, computing support and online classes. These services can be accessed from a range of personal computers using AOL's proprietary software. Microsoft Corp. develops, manufactures, licenses, sells, and supports a wide range of software products, including operating systems for personal computers and servers; server applications for client/server environments, business and consumer productivity applications; interactive media programs; and Internet platform and development tools. Microsoft also offers online services, sells personal computer books and input devices, and researches and develops advanced technology software products.
A. Describe how AOL and Microsoft share important elements of a vertical relationship.
B. Describe how AOL and Microsoft have important elements of a horizontal relationship.

Question 33

Agency Problem. In 2005, former WorldCom Inc. Chief Executive Bernard J. Ebbers was found guilty on charges of conspiracy, securities fraud and making false filings with the Securities and Exchange Commission in connection with what authorities have described as the largest accounting fraud in U.S. history. He could spend the rest of his life in jail.
A. What is the firm's potential agency problem?
B. What are agency costs within this firm?

Question 34

Virtual Corporation. Cendant Corporation provides travel and real estate services primarily in the United States and the United Kingdom. It operates in six segments: Real Estate Franchise and Operations, Hospitality Services, Travel Distribution Services, Vehicle Services, Mortgage Services, and Marketing Services. The Real Estate Franchise and Operations segment franchises the real estate brokerage businesses, provides real estate brokerage services, and assists in employee relocations through Cendant Mobility. Cendants's Hospitality Services segment operates eight lodging franchise systems; facilitates the sale, exchange, and development of time-share vacation ownership interests; and markets and manages vacation rental properties. The Travel Distribution Services segment provides travel content and services to consumers, travel agencies, corporations, and suppliers of travel products and services. The Vehicle Services segment operates and franchises its Avis and Budget vehicle rental businesses. Mortgage Services provides home buyers with mortgage lending services and title, appraisal, and closing services. And finally, the Marketing Services segment provides membership, loyalty, and insurance-based products and services to financial institutions and other partners.
A. What is the Coase Theorem?
B. Use the Coase Theorem to explain Cendant's recent operating and stock-market success.

Question 35

Transactions Costs. Centex Corp. is one of the nation's largest home builders, building and delivering, through its subsidiary Centex Homes, over 10,000 homes per year. Centex's housing operations currently involve the construction and sale of single-family and multi-family homes in over 50 different markets nationwide. These activities also include the purchase and development of land.
A. Use transactions costs to explain the existence of firms like Centex.
B. When will less formal contracting arrangements supplant the need for a formal corporate structure?

Question 36

Nature of the Firm. Dell Computer Corp. designs, develops, manufactures, markets, services and supports a wide range of computer systems, including desktops, notebooks and network servers, and also markets software, peripherals and service and support programs. They are the world's leading direct computer systems company and one of the top five computer vendors in the world.
A. Critics of Dell argue that the company is "merely" a retailer bringing together computer manufacturers and customers. Would Ronald Coase agree that this is a shortcoming of Dell?
B. In what way must Dell be efficient if it is to enjoy long-term success?

Question 37

Nature of the Firm. Amazon.com is a leading online retailer of books. The company also sells CDs, videotapes, audiotapes and other products over the Internet, and on proprietary online services like America Online. Amazon.com has a limited operating history upon which to base an evaluation of its business and prospects. The company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets such as online commerce.
A. Critics of Amazon.com allege that the company is "merely" an information processing device for bringing together book wholesalers and customers. Would Ronald Coase agree that this is a shortcoming of Amazon.com?
B. In what way must Amazon.com be efficient if it is to enjoy long-term success?

Question 38

Coase Theorem. Suppose a power plant reduced recreational opportunities by fouling a nearby river. A natural result would be for local environmentalists and consumers to petition local authorities for regulations outlawing or severely limiting such anti-social behavior. On the other hand, others might argue that there exist efficient and effective private-market solutions to such pollution problems.
A. What is the Coase Theorem?
B. Use the Coase Theorem to explain how the private sector might efficiently deal with pollution problems.

Question 39

The emergence of the virtual corporation can be explained by the:

A) feather-bedding practices of unions.
B) low cost of capital.
C) high cost of capital.
D) Coase Theorem.

Question 40

Horizontal and Vertical Relations. International Business Machines (IBM) develops, manufactures and sells advanced information processing products, including computers and microelectronic technology, software, networking systems and information technology-related services. The company offers value through its worldwide sales and service units in North America, Europe/Middle East/Africa, Asia Pacific and Latin America by providing comprehensive and competitive product choices. Microsoft Corp. develops, manufactures, licenses, sells, and supports a wide range of software products, including operating systems for personal computers and servers; server applications for client/server environments, business and consumer productivity applications; interactive media programs; and Internet platform and development tools. Microsoft also offers online services, sells personal computer books and input devices, and researches and develops advanced technology software products.
A. Describe how IBM and Microsoft share important elements of a vertical relationship.
B. Describe how IBM and Microsoft have important elements of a horizontal relationship.

Question 41

Excessive Risk Taking. In 2005, The Wall Street Journal reported that two founders of Amerindo Investment Advisors Inc., a money-management firm that makes outsized bets in technology stocks, were charged with stealing millions of dollars from investors to make charitable donations and buy thoroughbred racehorses. Alberto Vilar and Gary Tanaka were charged with fraud and arrested by U.S. Postal inspectors. Vilar and Tanaka made names for themselves by betting big on biotechnology and technology stocks. Their fund was an early investor in Web portal Yahoo Inc. and generated huge returns for its early investors, including many institutions and high net-worth individuals. The duo later created a mutual fund, which in 1999 reported a 249% return to investors.
After amassing a huge fortune in the late 1990s, Vilar pledged hundreds of millions of dollars to charities, including New York's Metropolitan Opera, Washington's Kennedy Center and New York University. Hurt by the bursting of the technology bubble and an exodus of investors, the firm's assets under management dropped from $8 billion in March 2000 to about $1.5 billion in 2005.
A. As a potential investor, what aspects of Amerindo's corporate governance system would you scrutinize to assure yourself that the firm's risk-seeking behavior was appropriate?
B. Explain why both Amerindo's insiders and outside investors might both share blame for this fiasco.

Question 42

Incentive Compensation. Salary and bonus payments tied to short-term performance often constitute a large part of the annual total compensation package earned by top management. Thus, top managers, like the chief executive officer (CEO), typically have huge personal incentives to turn in favorable year-to-year growth in revenues, profits and earnings per share. This can sometimes have the unfortunate effect of focusing managerial attention on near-term accounting performance to the detriment of long-term value maximization.
A. Explain some tools companies use to combat such myopic behavior.
B. Explain why a stock-option plan might be very appropriate for the CEO, but inappropriate for workers in general.

Question 43

Stock-market Indicators of Efficiency. According to the Efficient Market Hypothesis, current stock prices reflect all relevant risk and return information. This implies that near-term stock price changes are random and independent. In a rational pricing environment, investing in the stock market is a "fair game" where the expected excess return for each security is zero. Taken literally, this means that every stock at every point in time is an equally good buy (or sell). Within this context, the stock market provides a useful context within which to evaluate managerial decisions. "Good" decisions boost share prices, and "bad" decisions cause share prices to fall.
A. Does evidence of inefficiency in the stock market reduce its usefulness as an indicator of managerial efficiency?
B. Suppose that the stock market is very efficient, but not perfectly efficient. Can stock prices still be used to provide information about managerial efficiency?

Question 44

Corporate Governance. Empirical studies show a negative stock-price reaction for firms mentioned in Wall Street Journal announcements of law enforcement activities of three federal agencies: the Department of Justice (DOJ), Federal Trade Commission (FTC), and Securities and Exchange Commission (SEC). Evidence of negative stock market wealth effects exist for a variety of enforcement activities including: informal investigations, formal investigations, lawsuits and settlements.
A. Explain how actual or threatened legal action can act as a type of external corporate control mechanism.
B. Explain how the valuation effects of federal law enforcement actions can be expected to differ across firms according to the relative importance of intangible factors in firm valuation.

Question 45

Corporate Governance. In a fully informed stock market, news regarding the enforcement of federal laws against publicly traded firms would have no effect on target firm stock prices. A "rational expectations hypothesis" predicts that investors would be unaffected by announcements concerning the enforcement actions of federal agencies because current stock prices accurately reflect discounted future cash flows based upon all relevant information. An absence of announcement effects tied to federal law enforcement actions would suggest that the market is fully aware of illegal activity, the probability of getting caught, and the potential sanctions tied to detection and conviction. Future cash flows lost following federal law enforcement actions can include the costs of sacrificing illegal advantages over competitors, investigation expenditures, litigation expenses, and lost reputational capital. An absence of abnormal returns tied to federal law enforcement actions does not mean that there is no cost to being caught; it simply implies that the market correctly anticipates the magnitude and probability of such costs. Here it is important to recognize that the term "caught" does not necessarily imply guilt as well. Under the rational expectations hypothesis, market participants also know the probability of innocent firms being investigated or sued.
A. How would you interpret positive stock-price effects tied to public announcements regarding the enforcement actions of federal agencies?
B. Conversely, how would you interpret negative stock-price effects tied to public announcements regarding the enforcement actions of federal agencies?

Question 46

Organization Design. An effective organization design is one that allocates decision authority to that person or team of persons best able to perform a given task or influence a particular outcome. Decision authority allows individual employees to determine how and when to best deploy the productive resources and valuable information at their disposal. Of course, decision authority confers responsibility. It is thus imperative to monitor and evaluate performance. Managers and all employees must be held accountable for outcomes tied to individual decisions. Accountability can only be measured in terms of the tangible and intangible rewards derived from productive activity, and in terms of the penalties or sanctions tied to unproductive behavior. To minimize the costs of unproductive conflict with the firm, it is essential that the design of the organization effectively allocate decision making authority.
A. Describe centralized decision authority. Under what conditions does it work best?
B. What is decentralized decision authority, and when does it work best?

Question 47

Incentive Compensation. Salary and bonus payments tied to short-term performance often constitute a large part of the annual total compensation package earned by top management. Thus, top managers, like the chief executive officer (CEO), typically have huge personal incentives to turn in favorable year-to-year growth in revenues, profits and earnings per share. This can sometimes have the unfortunate effect of focusing managerial attention on near-term accounting performance to the detriment of long-term value maximization.
A. Identify some tools companies use to combat such myopic behavior.
B. Explain the pluses and minuses of stock options versus stock ownership as effective incentive devices.

Question 48

Executive Compensation. Roberto Goizueta did a superb job as head of soft-drink juggernaut Coca-Cola. During the 1980s and 1990s, Goizueta set an enviable standard for CEO performance in terms of global brand development, market share expansion, profitable asset deployment and market value creation. From when Goizueta took charge in 1981 until his death in 1998, Coca-Cola revenues grew at roughly 8% per year, earnings per share soared more than 16% per year, and its stock price skyrocketed a whopping 27% per year. In light of the company's outstanding performance, one can understand why the Coca-Cola board of directors awarded Goizeta generous salary, bonus and stock awards totaling over $1 billion dollars during his tenure.
A. Defend the hypothesis that Roberto Goizeta's accomplishments as CEO were worth $1 billion in total compensation.
B. Defend the hypothesis that nobody, not even Roberto Goizeta, is worth $1 billion in total compensation.

Question 49

Other Peoples' Money Problem. In 2008, France's Société Générale SA said that a 31-year-old trader named Jérôme Kerviel had cost the bank €4.9 billion (equivalent to $7.2 billion) by making huge unauthorized trades. Société Générale's loss dwarfed the $1.3 billion Nick Leeson cost Britain's Barings Bank in 1995, and forced Société Générale to seek a capital infusion of as much as €5.5 billion ($8 billion). Société Générale's loss was only one of many huge write offs tied to a general breakdown in risk controls at gigantic international financial institutions. In 2007-08, giant financial institutions around the world lost billions of dollars on complex financial instruments tied to subprime mortgages and various poorly designed trading strategies. Such losses had important and far-reaching economic ramifications. For example, Société Générale's frantic efforts to unwind Kerviel's unauthorized trades over a 72-hour period rattled global financial markets, and spurred dramatic moves by the Federal Reserve Board's Ben Bernanke to cut U.S. interest rates and head off a deep economic recession.
A. Explain this Société Générale bank episode as a manifestation of the "other peoples' money" problem.
B. How could it have been avoided?

Question 50

End-of-game Problem. One of the most vexing problems facing boards of directors and stockholders is the so-called "end-of-game" problem.
A. What is it?
B. How do firms efficiently deal with such difficulties?