BUSA ch 10 – Flashcards
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Excessive executive compensation, especially in the form of stock options, has largely been centered in technological companies.
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T
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When the price of the corporation's stock drops significantly, the firm is ethically compelled to reprice executives' stock options so that they will not lose expected gains when they exercise their stock options.
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F
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Corporate governance is the relationship among stakeholders that is used to determine and control an organization's strategic direction and performance.
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Corporate governance involves oversight in areas where owners, managers, and members of boards of directors may have conflicts of interest.
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In the United States, the fundamental goal of a firm is to maximize profits.
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F
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In the U.S., the members of the board of directors are a firm's key stakeholders and a company's legal owners.
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Executive compensation, ownership concentration, and the matrix organizational structure are all examples of internal governance mechanisms.
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F
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In a company such as Enron, one can argue that the company's governance system reflected Enron's standards as a company.
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T
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In the modern U.S. corporation, the ownership and managerial control of the firm are separated.
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T
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Amelia Smith is the sole owner of the successful restaurant chain, Amelia's Café. Ms. Smith has taken a no-interest loan from the company in order to build a luxurious seaside house for herself in Carmel, California. This constitutes a classic agency problem.
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F
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A top-level manager's reputation is a dependable predictor of his/her future behavior.
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F
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As a rule, shareholders prefer more product diversification than do managers because shareholders wish to reduce risk and maximize wealth.
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Both top executives and owners of the firm wish to diversify the firm to reduce risk.
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F
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Agency costs include incentives for executives, monitoring, enforcement costs, and any individual financial losses incurred by principals.
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T
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In general, when governance mechanisms are strong, managers have free rein in their decisions
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F
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Failures of corporate internal controls and inadequate internal control systems allowed unethical executives at such companies as Enron and Tyco to act in their own self-interest.
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T
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The impact of the Sarbanes-Oxley Act has been substantial on the governance processes of the firm, but overall firm strategy has been unaffected.
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F
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The ultimate in shareholder concentration would be one person holding all shares of a company's stock.
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In the U.S., institutional investors are mainly the primary lenders to the firm, usually banks.
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F
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The primary role of the board of directors is to monitor and control top-level executives to protect owners' interests.
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Generally, the board of directors can be classified as insiders, unrelated insiders, outsiders, and unrelated outsiders.
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F
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Boards with many members from the firm's top management team tend to have weak monitoring and control systems for managerial decisions.
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T
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DDD MetalWorks plans to go public in the next two years. In order to be listed on either the New York Stock Exchange or the American Exchange, the firm will need to restructure its present board of directors which is made up of insiders and related outsiders to a board of directors that is dominated by related outsiders and independent outsiders
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F
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A powerful CEO would oppose the appointment of a lead director on the board of directors.
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The CEO has the control of the corporate governance processes of the firm. This is why it is wise to separate the roles of CEO and chairperson of the board of directors.
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If a CEO has the intend to defraud the corporation and escape accountability, no amount of structural independence in the board of directors can stop him or her.
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The performance of individual board members is being evaluated more formally and with greater intensity than in years past.
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Because top management decisions are usually complex and nonroutine, determining the quality of executive performance is beyond the power of boards of directors.
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F
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Stock options attempt to align managers' and owners' interests by tying managerial compensation and firm performance together.
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T
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Executives whose bonuses are based on long-term outcomes (rather than short-term outcomes) by the firm are often relatively overcompensated because executives are reluctant to take on the additional risk.
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T
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Managers who own more than 1 percent of their firm's stock are less likely to be forced out of their jobs, even when the firm is performing poorly.
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T
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The key factor accounting for the amount of executive pay is firm performance.
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F
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When the option strike prices in an executive stock option-based compensation plan have been lowered it is usually a defense to a hostile takeover.
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F
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An active takeover market is referred to as the market for corporate control because takeovers are almost entirely focused on poorly-performing firms.
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Managers in firms that have been subjects of hostile takeovers usually find that their value to the new firm has been enhanced because of their in-depth insider knowledge.
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The top management of RavenCrest, Inc. is likely to be friendly to a takeover attempt by another firm because they have significant stock options in RavenCrest.
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Shareholders can rely on the market for corporate control to effectively discipline poor-performing executives if internal governance mechanisms fail.
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F
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Generous severance packages make executives less resistant to hostile takeovers.
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The most effective defense against a hostile takeover is the poison pill strategy.
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Large German firms must include employees, union members, and shareholders in the formal governance structure.
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Both Japan and the U.S. have market-based financial and corporate governance structures.
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F
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Corporate governance changes are occurring in developed countries, but few such reforms are taking place in transitional economies such as China and Russia
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F
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Japanese organizations' focus on stewardship-management produces greater investments in long-term research and development than does the U.S. system which is financially-oriented.
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The way that U.S. corporate boards of directors are presently structured, they have little influence on the unethical behavior of top management.
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F
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If a stakeholder is dissatisfied with a firm, it will withdraw its support and give it to another firm.
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Corporate governance mechanisms must serve the minimal needs of all stakeholders.
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T
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"The use of excessively-generous stock options for executive compensation has been slowed in the past couple years for all of the following reasons EXCEPT: a. criticism from corporate-governance activists. b. the Sarbanes-Oxley Act. c. a ruling by the Financial Accounting Standards Board. d. widespread shareholder resistance.
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D
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"Archibald Smith has moved from an upper-middle management job at Chromatic Array, Inc., to a similar position with Pixilair Corporation. The gap between CEO pay and the pay of other top executives at Chromatic was significantly larger than at Pixilair. What difference can Archibald expect? a. The working relationships among the top management team will be more collaborative at Pixilair than at Chromatic.b. The focus of Chromatic's board of directors will have been more on the creation of shareholder wealth than Pixilair's focus.c. The rating of Pixilair by Institutional Sharehold-ers Services will be less favorable than Chromatic's rating. d.Pixilair will be more vulnerable to hostile takeover than Chromatic.
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A
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Research suggests that firms with ____ perform better, especially when collaboration among top management team members is important: a. greater emphasis on stock options. b. larger proportion of insiders on the board of directors. c. smaller pay gap between the CEO and other top executives d.where benchmarking is used for top executive pay
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C
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A primary objective of corporate governance is to: a. determine and control the strategic direction of an organization, so that the top executives are focused on maximizing corporate profits.b. ensure that the interests of top-level managers are aligned with the interests of shareholders.c. lobby legislators to pass laws that are aligned with the organization's interests.d.resolve conflicts among corporate employees
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B
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Which of the following is a FALSE statement about corporate governance? a. Governance is used to establish order between parties whose interests may be in conflict.b. Corporate governance mechanisms sometimes fail to monitor and control top managers' decisions.c. Corporate governance mechanisms can be in conflict with one another. d.If properly established, the board of directors will remain effective as a governance mecha-nism for many years.
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D
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"In the U.S. the fundamental goal of business is to: a. ensure customer satisfaction.b. maximize shareholder wealth.c. provide job security. d. generate profits.
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B
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"In the U.S., a firm's key stakeholder(s) is(are) the: a. government.b. executives.c. shareholders. d. customers.
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C
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"Which of the following is NOT an internal governance mechanism? a. the board of directors b. ownership concentration c. executive compensation d.the market for corporate control
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D
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"Amos Ball, Inc., is a printing company in Iowa that has been family owned and managed for three generations. Which of the following statements is most likely to be TRUE? a. Agency costs at Amos Ball are high. b. If research findings are valid, Amos Ball, Inc., will perform better if a family member is CEO than if an outsider is CEO. c. At Amos Ball, the opportunity for managerial opportunism is high. d. The functions of risk-bearing and decision-making are separate at Amos Ball.
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B
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"The separation between firm ownership and management creates a(n) ____ relationship. a. governance b. control c. agency d. dependent
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C
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"Shareholder value is: a. the firm's free cash flow.b. the total revenue of the firm. c. determined by the size of the firm. d.reflected in the price of the stock.
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D
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"An agency relationship exists when one party delegates: a. decision making responsibility to a second party. b. financial responsibility to employees. c. strategy implementation actions to functional managers. d.ownership of a company to a second party.
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A
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"Managerial employment risk is the: a. risk that managers will behave opportunistically. b. risk undertaken by managers to earn stock options. c. managers' risk of job loss, loss of compensation, and/or loss of reputation. d.risk managers will not find a new top management position if they should be dismissed.
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C
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"Product diversification provides two benefits to managers that do not accrue to shareholders: ____ and ____.A. greater experience in a wider range of indus-tries, lessening of managerial employment risk b. the manager frequently invests in the acquired firm which allows them extensive profits, the manager can frequently buy excess assets divested by the acquired firm c. the manager's supervisory needs are lowered, the manager is allowed greater time to oversee a wider range of activities d.the opportunity for higher compensation through firm growth, a reduction in managerial employment risk
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D
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"The top management team at Sierra Infusion is concerned about the declining performance of firms in their industry. The team members are becoming concerned about the security of their jobs at Sierra Infusion. At a meeting over dinner, the top management team agrees to go to the board of directors with a proposal for: a. increased diversification of Sierra Infusion. b. the addition of outside directors to the board. c. increased shareholder participation in decision making. d.greater concentration on Sierra's core industry.
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A
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"In contrast to managers' desires, shareholders usually prefer that free cash flows be: a. used to diversify the firm. b. returned to them as dividends. c. used to reduce corporate debt. d.re-invested in additional corporate assets.
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B
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"A major conflict of interest between top executives and owners, is that top executives wish to diversify the firm in order to ____, while owners wish to diversify the firm to ____.a. generate free cash flows, reduce the risk of total firm failure b. increase the price of the firm's stock, increase the dividends paid out from free cash flows c. reduce the risk of total firm failure, reduce their total portfolio risk d.reduce their employment risk, increase the company's value
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D
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Agency costs reflect all of the following EXCEPT ____ costs. a. monitoring b. enforcement c. opportunity d.incentive
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C
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All of the following are unintended consequences of the Sarbanes-Oxley Act EXCEPT: a. some foreign firms have delisted on U.S. stock exchanges. b. a number of publicly-traded companies have decided to privatize.c. an increased number of IPOs (initial public offerings) are expected. d.internal auditing costs have increased by about one-third.
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C
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The Sarbanes-Oxley Act requires all of the following EXCEPT: a. installation of an outsider as the lead director on the Board of Directors. b. accounting firms are forbidden from providing both auditing and consulting services to clients.c. CEOs and CFOs must personally certify the company's financial reports. d.independence of the committees on the firm's Board of Directors.
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A
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"Compared to managers, shareholders prefer: a. safer strategies with greater diversification for the firm. b. riskier strategies with more focused diversifica-tion for the firm. c. safer strategies with more focused diversifica-tion for the firm. d.riskier strategies with greater diversification for the firm.
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B
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"Usually, large block shareholders are considered to be those shareholders with at least ____ percent of the firm's stock. a. 5 b. 25 c. 50 d.75
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A
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"Recent research evidence shows that ownership concentration is associated with: a. increases in executive compensation. b. greater managerial autonomy. c. lower levels of product diversification. d.companies in mature, slow-cycle industries.
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C
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"As ownership of the corporation is diffused, shareholders' ability to monitor managerial decisions: a. increases. b. decreases. c. remains constant. d.is eliminated.
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B
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"Institutional owners are: a. shareholders in the large institutional firms listed on the New York Stock Exchange. b. banks and other lending institutions that have provided major financing to the firm. c. large block shareholders such as mutual funds and pension funds. d.prevented by the Sarbanes-Oxley Act from owning more than 50% of the stock of any one firm.
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C
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"The ownership of major blocks of stock by institutional investors have resulted in all of the following EXCEPT: a. making CEOs more accountable for their performance. b. increasing the concentration of ownership of large U.S. firms. c. focusing attention on ineffective boards of directors. d.tying the compensation of CEOs to measur-able financial criteria.
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D
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"The board of directors of Acme Brands is discussing the design of a very generous stock option plan for its top executives. During the debate, one of the directors raises the point that CalPERS owns a significant portion of Acme Brand stock. Which of the following statements is likely to be TRUE? a. This will have no effect on the stock option plan design discussion, because CalPERS' main concern is stock dividends. b. CalPERS' interest in Acme Brands will cause the directors to reduce the size of the stock option plan from what it would otherwise have been. c. CalPERS supports generous stock option plans for executives because it motivates under-performing executives. d.For legal reasons, the board cannot consider the interests of CalPERS over the interests of its top executives.
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B
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"Research suggests that the activism of institutional investors such as TIAA-CREF and CalPERS: a. increases shareholder value significantly. b. may not have a direct effect on firm performance. c. is so aggressive that boards of directors have become overly cautious. d.has weakened the effect of other governance mechanisms.
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B
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"Monitoring by shareholders is usually accomplished through: a. management consultants. b. government auditors. c. the firm's top managers. d.the board of directors.
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D
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"Generally, a board member who is a source of information about a firm's day-to-day activities is classified as a(an) ____ director. a. lead independent b. inside c. related d.encumbered
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B
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"A virtually exclusive reliance on financial controls may occur when outsider-dominated boards exist. This may lead to all EXCEPT: a. high executive turnover. b. increased diversification of the firm. c. excessive management compensation. d. reduction in R&D expenditure.
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A
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"The New York Stock Exchange requires that the audit committee be: a. available to comment to external analysts. b. composed solely of outside directors. c. liable for any illegal actions by the top management team. d.made up of CPAs with auditing experience.
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B
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"Simon Leagreet, the Chairperson and CEO of L-EVA Industries, Inc., has long been the major power at L-EVA. A majority of the directors are concerned that while Mr. Leagreet has been responsible for the firm's earning above-average returns, that he has been displaying a tendency toward personal extravagance at the firm's expense. In order to limit Mr. Leagreet's power, Board of Directors plans to: a. elect an insider as the lead director. b. appoint another individual as chairperson of the Board of Directors. c. require Mr. Leagreet to personally certify the firm's financial reports. d.reduce the size of the stock option package provided to Mr. Leagreet.
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B
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"Several members of the board of directors of American Textile Products (ATP) have proposed creating the position of lead director. What circumstances would most likely have initiated this proposal? a. ATP has been the initiator of several hostile takeovers in the last two years. b. The board has been successful in reducing the percentage of CEO pay that is composed of stock options. c. The CEO/Chairperson of the Board has been suspected of opportunistic behavior. d.The firm is traded on the New York Stock Exchange and must change its corporate governance to comply with the NYSE's new rules.
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C
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"The argument for having one individual serve as CEO and chairperson of the Board of Directors is that this: a. provides unified leadership and direction for the firm. b. strengthens the governance processes of the firm. c. gives the Board of Directors more power. d.is less expensive than maintaining two top executives.
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A
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"Given the demands for greater accountability and improved performance, which of the following is NOT a voluntary change many boards of directors have initiated? a. moving toward having directors from different backgrounds b. strengthening the internal management and accounting control systems c. compensating directors with stock options rather than with fixed remuneration. d.establishing and using formal processes to evaluate the board's performance
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C
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"Boards of directors are now becoming more involved in: a. the strategic decision making process. b. selecting new CEOs. c. the firm's tax issues. d.governmental relations.
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A
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"Research suggests that boards of directors perform better if: a. the CEO is also the chairperson of the board of directors. b. the board includes employees as voting members. c. the board is homogenous in composition. d.outside directors own significant equity in the organization.
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D
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"One means that is considered to improve the effectiveness of outside directors is: a. mandating that all outside directors be drawn from government or academia rather than industry. b. requiring that outside directors be former executives of the firm. c. requiring outside directors to own significant equity stakes in the firm. d.requiring that outside directors be truly objective by having no ownership interest in the firm.
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C
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"Executive compensation is a governance mechanism that seeks to align managers' and owners' interests through all of the following EXCEPT: a. bonuses. b. long-term incentives such as stock options. c. salary. d.penalties for inadequate firm performance.
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D
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"The interests of multinational corporations' shareholders may be best served when there is: a. a uniform compensation plan for all corporate executives, U.S. and foreign alike. b. executive compensation that is primarily based on long-term performance. c. elevation of foreign executive compensation to U.S. levels. d.a variety of compensation plans for execu-tives of foreign subsidiaries.
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D
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"Managers in the U.S. receive ____ compensation than managers in the rest of the world. a. equivalent b. higher c. lower d.more variable
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B
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"Top executives resist tying their compensation to long-term performance of the firm mainly because: a. this delays their compensation for present actions to future years. b. long-term firm performance is more easily manipulated by the board of directors through financial and accounting methods than are shorter-term measures of firm performance. c. uncontrollable events may affect the long-term performance of the firm. d.CEOs and other top executives tend to hold their jobs for five years or less, meaning they are not employed by the firm for the appropriate period of time.
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C
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"There is some evidence that performance bonuses for executives based on annual results are ____ investments in R&D where the firm was highly diversified. a. negatively related to: b. positively related to c. not correlated with d.curvilinearly related to
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A
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"The longer the focus of managerial incentive compensation, the greater the ____ top-level managers.a. earnings potential for: b. risks borne by c. incentives for d.potential tax burden for
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B
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"Which of the following reasons would NOT explain the difficulty of determining appropriate executive compensation? a. The decisions made by top-level managers are typically complex and nonroutine. b. An executive's decisions often affect firm performance only over the long run. c. A number of factors intervene between top-level management decisions and firm performance. d.The compensation committee may not have comprehensive firm performance data.
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D
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"The major determinant of CEO pay is(are): a. organizational performance. b. organizational size. c. the qualifications and experience of the CEO. d. the proportion of insiders on the board of directors.
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B
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"The board of directors of CamCell, Inc., wishes to design a CEO compensation plan that will align the personal interests of the CEO with the interests of the shareholders in long-term firm performance. The board wishes the CEO to take more short-term risks in order to achieve potentially higher long-term returns. Consequently, the board has decided on an incentive plan that involves payout based on the firm's performance five years in the future. CamCell is presently searching for a new CEO. Which of the following statements is true? a. This plan will be very attractive in luring candidates for the CEO position. b. CamCell may have to over-compensate its CEO in order to offset the personal risk a CEO would undertake under this plan. c. Institutional investors disapprove of long-term executive incentive plans and they may sell their blocks of stock in CamCell. d.This type of plan is likely to cause the CEO to underinvest in R&D in order to boost CamCell's long-term profitability.
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B
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"The market for corporate control serves as a means of governance when: a. the firm is overpriced in the market. b. internal controls have failed. c. the corporation has greatly exceeded perform-ance expectations. d.the top management team's interests and the owners' interests are aligned.
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B
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"There is some evidence that those firms targeted for takeover by active corporate raiders are: a. usually on the verge of bankruptcy. b. typically under-performing their industry. c. often performing above their industry averages. d.always outperforming their industry.
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C
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"If the market for corporate control were efficient as a governance device, then only ____ would be targets for takeovers.a. firms with unethical top executives b. firms earning above-average returns c. poorly-performing firms d.over-valued firms
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C
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"The board of directors of CyberScope, Inc., is designing a stock option plan for its CEO that will motivate the CEO to increase the market value of the firm. Consequently, the board is: a. setting the option strike price substantially higher than the current stock price. b. insuring that the strike price value of the options can be lowered if the organizational environ-ment becomes more risky. c. having the stock option plan designed by insiders on the board of directors who are familiar with day-to-day operations of the firm. d.consulting accounting advisors to make sure that the plan transfers wealth to the CEO without immediately appearing on the balance sheet of CyberScope.
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A
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When executives have ownership positions or stock options with their employing firm, they are: a. going to actively defend their firm from takeover attempts. b. likely to gain financially if their employing firm is taken over by another. c. pressure the board of directors to reprice their stock options. d.likely to be terminated by the acquiring firm even in a friendly takeover.
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B
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Agricultural Chemicals, Inc., was the target of a hostile takeover six months ago. The CEO and the top executives successfully fended off the takeover and are concentrating on strategies to improve the performance of the firm. Which of the following is most likely to be TRUE? a. Hostile takeover attempts are so common that they do not reflect negatively on the firm's performance. They are more a function of general market conditions. b. The fact that a hostile takeover has occurred is proof that the firm was under-performing. c. Research shows that once a hostile takeover has been defeated, the firm is safe from other hostile takeover attempts for many years. d. The CEO and top executives should not consider their jobs secure.
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D
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"All of the following statements are TRUE about the use of defense tactics by the target firm during a hostile takeover EXCEPT: a. defense tactics are usually beneficial for the executives of the target firm. b. defense tactics are opposed by institutional investors. c. defense tactics are typically ineffective in deterring the takeover. d.defense tactics make the costs of a takeover lower.
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D
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Ambrose Bierce, the CEO of DictionAry, has been paid a lump sum amounting to three years' salary because DictionAry has been bought in a hostile takeover by its main competitor. Ambrose received: a. a golden parachute. b. a poison pill. c. greenmail. d.a silver handshake.
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A
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The repurchase at a premium of shares of stock that have been acquired by the aggressor firm in a hostile takeover in exchange for an agreement that the aggressor will no longer target the company for takeover is called: a. greenmail. b. a standstill agreement. c. crossing the palm with silver. d.a poison pill.
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A
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Historically, ____ have been at the center of the German corporate governance structure. a. banks b. institutional shareholders c. public pension funds d.government agencies
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A
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James Abercrombie has a thriving consulting firm specializing in training boards of directors in decision-making skills. Mr. Abercrombie has had striking success in reducing conflict and hostility among directors and allowing boards to develop more cohesiveness. Mr. Abercrombie is considering expanding his consulting practice overseas. Which of the following statements is most likely to be TRUE? a. Mr. Abercrombie will have a large market in Japan because the culture highly values consensus decision making. b. Japanese firms will have little interest in Mr. Abercrombie's specialty because these skills are already practiced at a high level. c. German firms will not be interested in Mr. Abercrombie's services because the German system of decision-making is based on authority and few conflicts emerge. d.Mr. Abercrombie should find significant need for his services in companies in transitional economies.
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B
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German executives are not dedicated to the maximization of shareholder value largely because: a. the roles of CEO and chairperson of the board of directors are usually combined. b. large institutional investors control large blocks of stock. c. private shareholders rarely have large ownership positions in the firm. d.of the focus on stewardship-management in German firms rather than the financial perform-ance focus of U.S. firms
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C
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Which of the following statements is FALSE? a. The Vorstand of a German corporation makes decisions about organization direction and management. b. The Vorstand is elected by the firm's employees. c. Membership of U.S. boards of directors is less directly influenced by the company's employees than is the membership of German Aufsichsrat. d. Banks have less influence on the governance of German corporations than they do on U.S. corporations.
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B
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"Japanese keiretsu are: a. management structures related to total quality management systems. b. company unions which are a type of governance system. c. the banks owing the largest shares of stock in the firm. d. a system of cross-shareholding among firms.
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D
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"In Japan, the principal source of the active monitoring of large companies comes from: a. boards of directors. b. stock brokerage companies. c. the government. d.banks.
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D
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____ is an important influence in Japanese corporate governance structures. a. Innovation b. Consensus c. Competition d.Individualism
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B
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"Which of the following is TRUE of trends in Japan's corporate governance structure? a. Some major Japanese firms are bringing in more outsiders onto their boards of directors.b. The market for corporate control has collapsed with the economic crises in Japan.c. Banks' influence over corporations is increas-ing. d.Traditionally privately-owned Japanese firms are going public.
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A
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"The CEO of Skyco, a publicly-traded company that has been earning below-average returns, has been publicly criticized by shareholders for persuading the board of directors to give her interest-free loans, for having the company purchase and furnish a lavish apartment in Paris for her personal use on her twice-yearly trips there, and for excessive stock options. The CEO's behavior may be indication of: a. reasonably compensating a CEO. b. a weak board of directors. c. the laxity of institutional investors. d.the difference in risk propensity between owners and managers.
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B
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"The governance mechanism most closely connected with deterring unethical behaviors by holding top management accountable for the corporate culture is: a. ownership concentration. b. the market for corporate control. c. executive compensation systems. d.the board of directors.
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D
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"International Food Services (IFS) has a contract with the Marines to supply meals for it troops in Iraq and other foreign assignments. As a means of increasing profits, IFS has used substandard ingredients in these meals and has consistently lied about this practice during quality investigations by the Marines. Who is ultimately responsible for the corporate climate that resulted in this wrongdoing?a. the director of food service for IFS. b. the board of directors of IFS. c. the employees directly involved in the wrongdo-ing. d.the head of contract services for the Marines
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B
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ESSAY: What is corporate governance and how is it used to monitor and control managers' decisions?
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Corporate governance is the relationship among stakeholders that is used to determine and control the firm's strategic direction and its performance. Effective governance that aligns top-level managers' interests with shareholders' interests can produce a competitive advantage for the firm. Corporate governance includes oversight in areas where there are conflicts of interest among major stakeholders, including the election of directors, supervision of CEO pay, and the organization's overall structure and strategic direction. Three internal governance mechanisms (ownership concentration, the board of directors, and executive compensation) and an external mechanism (the market for corporate control) are used in U.S. corporations. Unfortunately, corporate governance mechanisms are not always successful.
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ESSAY: Discuss the effect of the separation of ownership and control in the modern corporation.
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Ownership is typically separated from control in the large U.S. corporation. Owners (principals) hire managers (agents) to make decisions that maximize the value of their firm. As risk specialists, owners diversify their risk by investing in an array of corporations. As decision-making specialists, top executives are expected by owners to make decisions that will result in earning above-average returns for which they are compensated. Thus, the typical corporation is characterized by an agency relationship that is created when one party (the firm's owners) hires and pays another party (top executives) to use decision-making skills. Since owners may not possess the specialized skill to run a large company, delegating these tasks to managers should produce higher returns for owners.
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ESSAY: Define the agency relationship and managerial opportunism and discuss their strategic implications.
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The separation of owners and managers creates an agency relationship. An agency relationship exists when a principal hires an agent as a decision-making specialist to perform a service. Some problems that result from the agency relationship between owners and managers include the potential for a divergence of interests and a lack of direct control of the firm by shareholders. Managerial opportunism is the seeking of self-interest with guile. It is both an attitude and a set of behaviors, which cannot be perfectly predicted from the agent's reputation. Top executives may make strategic decisions that maximize their personal welfare and minimize their personal risk, such as excessive product diversification. Decisions such as these prevent the maximization of shareholder wealth, which is supposed to be the top executives' priority. Although shareholders implement corporate governance mechanisms to protect themselves from managerial opportunism, these mechanisms are imperfect. Agency costs include the costs of managerial incentives, monitoring costs, enforcement costs, and the individual financial losses incurred by principals (owners of the firm) because governance mechanisms cannot guarantee total compliance by the agents (managers).
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ESSAY: Define the three internal corporate governance mechanisms and how they may be used to control and monitor managerial decisions.
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The three internal corporate governance mechanisms are: ownership concentration, the board of directors, and executive compensation. Ownership concentration is based on the number of large-block shareholders and the percentage of shares they own. With significant ownership percentage, institutional investors, such as mutual funds and pension funds, are often able to influence top executives' strategic decisions and actions. Thus, unlike diffuse ownership, which tends to result in relatively weak monitoring and control of managerial decisions, concentrated ownership produces more active and effective monitoring of top executives. An increasingly powerful force in corporate America, institutional owners are actively using their positions of concentrated ownership in individual companies to force managers and boards of directors to make decisions that maximize a firm's value. These owners (e.g., CalPERS) have caused poorly-performing CEOs to be ousted from the firm. The board of directors, elected by shareholders, is composed of insiders, related outsiders, and outsiders. The board of directors is a governance mechanism shareholders expect to run the firm in such a ways as to maximize shareholder wealth. Outside directors are expected to be more independent of a firm's top executives than are those who hold top management positions within the firm. A board with a significant percentage of insiders tends to be weak in monitoring and controlling management decisions. Boards of directors have been criticized for being ineffective, and there is a movement to more formally evaluate the performance of boards and their individual members. Executive compensation is a highly visible and often criticized governance mechanism. Salary, bonuses, and long-term incentives such as stock options are intended to reward top executives for aligning their goals with the interests of shareholders. A firm's board of directors has the responsibility of determining the degree to which executive compensation succeeds in controlling managerial behavior. But, it is difficult to evaluate top executives' performance, and so executive compensation tends to be linked to financial measures which do not necessarily reflect the effectiveness of the executive's decision on long-term shareholder outcomes. In addition, many external factors affect the performance of a firm. Moreover, performance incentive plans can be subject to management manipulation. Consequently, executive compensation is a far-from-perfect governance mechanism.
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ESSAY: Discuss the difficulties in establishing performance-based compensation plans for executives.
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Executive compensation, especially long-term incentive compensation, is complicated. First, the strategic decisions made by top-level managers are typically complex and nonroutine; as such, direct supervision of executives is inappropriate for judging the quality of their decisions. Because of this, there is a tendency to link the compensation of top-level managers to measurable outcomes such as financial performance. Second, an executive's decision often affects a firm's financial outcomes over an extended period of time, making it difficult to assess the effect of current decisions on the corporation's performance. In fact, strategic decisions are more likely to have long-term, rather than short-term, effects on a company's strategic outcomes. Third, a number of other factors affect firm performance. Unpredictable economic, social, or legal changes make it difficult to discern the effects of strategic decisions. Thus, although performance-based compensation may provide incentives to managers to make decisions that best serve shareholders' interests, such compensation plans alone are imperfect in their ability to monitor and control managers. Although incentive compensation plans may increase firm value in line with shareholder expectations, they are subject to managerial manipulation. For instance, annual bonuses may provide incentives to pursue short-run objectives at the expense of the firm's long-term interests. Supporting this conclusion, some research has found that bonuses based on annual performance were negatively related to investments in R&D, which may affect the firm's long-term strategic competitiveness. Although long-term performance-based incentives may reduce the temptation to under invest in the short run, they increase executive exposure to risks associated with uncontrollable events, such as market fluctuations and industry decline. Long-term incentives may not be highly-valued by a manager, thus, firms may have to overcompensate managers when they use long-term incentives.
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ESSAY: Describe the market for corporate control and its implications for organizations.
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The market for corporate control is composed of individuals and firms who buy ownership positions in (e.g., take over) potentially undervalued firms to form a new division in an established firm or to merge the two previously-separate firms. The target firm's top management team is usually replaced because it is assumed to be partly responsible for formulating and implementing the strategy that led to poor firm performance. The market for corporate control is (supposedly) triggered by low corporate performance by a firm relative to competitors in its industry. Thus, the market for corporate control should act as a control mechanism for corporate governance that leads to the replacement of under-performing executives. But, the market for corporate control is not an efficient governance mechanism because in reality many of the firms taken over have above-average performance. Hostile takeovers, on the other hand, are typically triggered by poor performance. Some managers have sought to buffer themselves from the effect of the market for corporate control (hostile takeovers) by instituting golden parachutes that will pay the managers significant extra compensation if the firm is taken over. Those and other takeover defenses are intended to increase the costs of mounting a takeover and reducing the managers' risk of losing their jobs. Examples of takeover defenses include asset restructuring, changes in the financial structure of the firm, reincorporation in another state, and greenmail. These defense tactics are controversial and the research on their effectiveness is inconclusive. Most institutional investors oppose them.
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ESSAY: Briefly compare and contrast corporate governance in the U.S., Germany, and Japan.
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Corporate governance structures used in Germany and Japan differ from each other and from the ones used in the U.S. Historically, the U.S. governance structure has focused on maximizing shareholder value. Banks have been at the center of the German corporate governance structure, because as lenders, banks become major shareholders in the firms. Shareholders usually allow the banks to vote their ownership positions, so banks have majority positions in many German firms. The German system has other unique features. For example, German firms with more than 2,000 employees are required to have a two-tier board structure, separating the board's management supervision function from other duties that it would normally perform in the U.S. (e.g., nominating new board members). Historically, German executives have not been dedicated to the maximization of shareholder value, because private shareholders rarely have major ownership in German firms, nor do larger institutional investors play a significant role. Attitudes toward corporate governance in Japan are affected by the concepts of obligation, family, and consensus. Japan continues to follow a bank-based financial and corporate governance structure compared to the market-based financial and corporate governance structure in the United States. In addition, Japanese firms belong to keiretsu, groups of firms tied together by cross-shareholding. In many cases, the main-bank relationship of the firm is part of a keiretsu. However, the influence of banks in monitoring and controlling managerial behavior and firm outcomes is beginning to lessen and a minor market for corporate control is emerging.
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Case Scenario 1: Abramson's Jewelers. Abramson's Jewelers has established a strong niche market in the upscale jewelry store segment. Abramson's was founded in 1871 and its current single-store location is owned and operated by John Wickersham, who bought the firm from its namesake founders in 1985. Over the last 15 years, Mr. Wickersham has narrowed the company's product offering considerably to focus only on high-end watches like Rolex and Piaget, custom jewelry, and estate jewelry. Mr. Wickersham stresses that this is an appropriate focus for his business since each of the products lends itself to relationship selling, and price rarely comes into the discussion. Despite the narrower offering, Abramson's floor space has doubled, and clients are intensely loyal to the good taste, design skills, and personal service level provided by Mr. Wickersham. After evaluating several expansion options, Mr. Wickersham has decided to open another store in a neighboring city. While it is likely that some of his existing customers may begin doing business at the other location, thus lowering sales volume at the original store, Mr. Wickersham sees this as a desirable increase in the level of service and convenience he can provide his existing clientele. At the same time, he believes that he will be able to grow the overall business faster with two locations. He has identified another reputable gemologist, Jill Diamond, to run the other store and is now considering how to compensate her.1. (Refer to Case Scenario 1) What are the advantages and disadvantages of paying the new manager primarily cash pay? 2. (Refer to Case Scenario 1) What are the advantages and disadvantages of paying the new manager primarily on new store sales growth?3. (Refer to Case Scenario 1) What compensation structure would you recommend?
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1 ANS: Answers should begin by suggesting that both components of pay are important and that some balance needs to be struck between the two. A fair level of cash pay can motivate Jill to keep the existing business running at a high service level for existing customers. An added incentive pay component can provide her with additional motivation to grow the business. The best answers here will take the concept of incentive pay further to suggest that Wickersham can establish a number of objectives for which the incentive pay can be earned. Such a balanced scorecard approach provides Jill with the incentive to manage the whole store, and not one or two particular dimensions of it. 2 ANS: The best answers here will contrast the benefits of cash to incentive pay, and note that incentive pay will focus Jill's efforts on increasing the customer base and the dollar sales per customer. A potential negative consequence would be for Jill to lose sight of customer service (retention), since she is working so hard to generate new sales. 3 ANS: The best answers will note, assuming Jill has an interest in seeing the store do well, that cash pay may let Jill focus on maximizing the level of service provided to the extant customer base. In terms of drawbacks, there is little incentive for her to grow the business, which is what Mr. Wickersham is aiming for.
