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1.
Who owns a corporation? Shareholders
Describe the process whereby the owners control the firm ’ s management. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. What is the main reason that an agency relationship exists in the corporate form of organization? Separation of ownership and control In this context, what kinds of problems can arise? Management may act in its own or someone else’s best interests 2. Suppose you were the financial manager of a not-for- profit business (a not-for- profit hospital, perhaps). What kinds of goals do you think would be appropriate? revenue minimization -> lowest cost maximize the value of the equity 3. Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits. FALSE -> reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term 4. Can the goal of maximizing the value of the stock conflict with other goals, such as avoiding unethical or illegal behavior? Either way In particular, do you think subjects like customer and employee safety, the environment, and the general good of society fit in this framework, or are they essentially ignored? Either way ->ethical and/or illegal behavior, and the framework of stock valuation explicitly includes these. ->these are non-economic phenomena and are best handled through the political process. Think of some specific scenarios to illustrate your answer. “A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do?” 6. Suppose you own stock in a company. The current price per share is $25. Another company has just announced that it wants to buy your company and will pay $35 per share to acquire all the outstanding stock. Your company’s management immediately begins fighting off this hostile bid. Is management acting in the shareholders ’ best interests? Why or why not? S1: -> management believes that it can improve the profitability of the firm so that the share price will exceed $35 ->management believes that this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the company S2:the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in and current managers often lose their jobs when the corporation is acquired is not acting in the interests of the shareholders 8. In recent years, large financial institutions such as mutual funds and pension funds have become the dominant owners of stock in the United States, and these institutions are becoming more active in corporate affairs. What are the implications of this trend for agency problems and corporate control? -> lead to a reduction in agency problems and a more efficient market for corporate control. If the managers of the mutual fund or pension plan are not concerned with the interests of the investors, the agency problem could potentially remain the same, or even increase 9. Critics have charged that compensation to top managers in the United States is simply too high and should be cut back. For example, focusing on large corporations, Larry Ellison of Oracle has been one of the best-compensated CEOs in the United States, earning about $130 million in 2010 alone and over $1 billion during the 2006 – 2010 period. Are such amounts excessive? In answering, it might be helpful to recognize that superstar athletes such as Tiger Woods, top earners in the entertainment field such as James Cameron and Oprah Winfrey, and many others at the top of their respective fields earn at least as much, if not a great deal more. Compensation schemes awarded by preferred shares will help managers work for the benefit of shareholders more. Therefore, a cut in bonuses and bonuses will lose managers' good incentive to maximize the current stock value, which can easily lead to agency problems. 10. Why is the goal of financial management to maximize the current share price of the company’s stock? In other words, why isn’t the goal to maximize the future share price? -> Maximizing the current share price is the same as maximizing the future share price at any future period. ->The value of a share of stock depends on all of the future cash flows of company. -> Expect higher value in the future