Ch004 Corporate Governance Around the World

Eun & Resnick 4eCHAPTER 4 Corporate Governance Around the WorldGovernance of the Public Corporation: Key IssuesThe Agency ProblemRemedies for the Agency ProblemBoard of DirectorsInternational Finance in Practice: When Boards Are All in the FamilyIncentive ContractsConcentrated OwnershipAccounting TransparencyDebtOverseas Stock ListingsMarket for Corporate ControlLaw and Corporate GovernanceConsequences of LawOwnership and Control PatternPrivate Benefits of ControlCapital Markets and ValuationCorporate Governance ReformObjectives of ReformPolitical DynamicsThe Cadbury Code of Best PracticeSummaryMINI CASE: Parmalat: Europe’s Enron1Corporate governance can be defined as:a) the economic, legal, and institutional framework in which corporate control and cash flowrights are distributed among shareholders, managers and other stakeholders of thecompanyb)the general framework in which company management is selected and monitoredc) the rules and regulations adopted by boards of directors specifying how to managecompaniesd)the government-imposed rules and regulations affecting corporate management Answer: a)2When managerial self-dealings are excessive and left uncheckeda)They can have serious negative effects on share valuesb)They can impede the proper functions of capital marketsc)They can impede such measures as GDP growthd)All of the aboveAnswer: d)3Corporate governance structurea)Varies a great deal across countriesb)Has become homogenized following the integration of capital marketsc)Has become homogenized due to cross-listing of shares of many public corporationsd)None of the aboveAnswer: a)Governance of the Public Corporation: Key Issues4The central issue of corporate governance isa)how to protect creditors from managers and controlling shareholdersb)how to protect outside investors from the controlling insidersc)how to alleviate the conflicts of interest between managers and shareholdersd)how to alleviate the conflicts of interest between shareholders and bondholders Answer: b)5The key weakness of the public corporation isa)too many shareholders, which makes it difficult to make corporate decisionb)relatively high corporate income tax ratesc)conflicts of interest between managers and shareholdersd)conflicts of interests between shareholders and bondholdersAnswer: c)6When company ownership is diffuse,a) A “free rider” problem discourages shareholder activismb)The large number of shareholders ensures strong monitoring of managerial behaviorbecause with a large enough group, there’s almost always someone who will to incur the costs of monitoring management.c)Few shareholders have a strong enough incentive to incur the costs of monitoringmanagement.d)a) and c) are correctAnswer: d)7In what country do the three largest shareholders control, on average, about 60 percent of the shares of a public company?a)United Statesb)Canadac)Great Britaind)ItalyAnswer: d)8The public corporationa)Is jointly owned by a (potentially) large number of shareholdersb)Offers shareholders limited liabilityc)Separates the ownership and control of a firms assetsd)All of the aboveAnswer: d)9The key strengths of the public corporation is/area)Their capacity to allow efficient risk sharing among many investorsb)Their capacity to raise large amounts of funds at relatively low costc)Their capacity to consolidate decision-makingd)All of the aboveAnswer: d)10In theory,a)Managers are hired by the shareholders at the annual stockholders meeting. If the managersturn in a bad year, new ones get hired.b)Shareholders hire the managers to oversee the board of directors.c)Managers are hired by the board of directors; the board is accountable to the shareholders.d)None of the aboveAnswer: c)11In many countries with concentrated ownershipa)The conflicts of interest between shareholders and managers are worse than in countrieswith diffuse ownership of firms.b)The conflicts of interest are greater between large controlling shareholders and smalloutside shareholders than between managers and shareholders.c)The conflicts of interest are greater between managers and shareholders than between largecontrolling shareholders and small outside shareholdersd)Corporate forms of business organization with concentrated ownership are rare Answer: b)12In the reality of corporate governance at the turn of this century,a)Boards of directors are often dominated by management-friendly insiders.b) A typical board of directors often has relatively few outside directors who canindependently and objectively monitor the management.c)Managers of one firm often sit on the boards of other firms, whose managers are on theboard of the first firm. Due to the interlocking nature of these boards, there can exist aculture of “I’ll overlook your problems if you overlook mine.”d)All of the above have been true to a greater or lesser extent in the recent past. Answer: d)The Agency Problem13A complete contract between shareholders and managersa)Would specify exactly what the manager will do under each of all possible futurecontingenciesb)Would be an expensive contract to write and a very expensive contract to monitor.c)Would eliminate any conflicts of interest (and managerial discretion)d)All of the aboveAnswer: d)14Most shareholders are “weak” in that they give up control to the managers of the firm.a)This may be rational when shareholders may be neither qualified nor interested in makingbusiness decisions.b)This may be rational since many shareholders find it easier to sell their shares in anunderperforming firm than to monitor the managementc)This may be rational to the extent that managers are answerable to the board of directorsd)All of the above are explanations for the separation of ownership and control. Answer: d)15Free cash flow refers toa) a firm's cash reserve in excess of tax obligationb) a firm's funds in excess of what's needed for undertaking all profitable projectsc) a firm's cash reserve in excess of interest and tax paymentsd) a firm's income tax refund that is due to interest payments on borrowingAnswer: b)16Self-interested managers may be tempted toa)Indulge in expensive perquisites at company expenseb)Adopt antitakeover measures for their company to ensure their personal job securityc)Waste company funds by undertaking unprofitable projects that benefit themselves but notshareholdersd)All of the above are potential abuses that self-interested managers may be tempted to visitupon shareholders.Answer: d)17Why do managers tend to retain free cash flow?a)Managers are in the best position to decide the best use of those fundsb)These funds are needed for undertaking profitable projects and the issue costs are less thannew issues of stocks or bonds.c)Managers may not be acting in the shareholders best interest, and for a variety of reasons,want to use the free cash flow.d)None of the aboveAnswer: c)Rationale: Free cash flow is defined as firm's funds in excess of what's needed for undertaking all profitable projects.18The agency problem tendsa)To be more serious in firms with free cash flowsb)To be more serious in firms with excessive amounts of excess cashc)To be less serious in firms with few numbers of shareholdersd)All of the aboveAnswer: d)Remedies for the Agency ProblemBoard of Directors19In the United Statesa)Boards of directors are legally responsible for representing the interests of the shareholdersb)Due to the diffused ownership structure of the public company, management often gets tochoose board members who are likely to be friendly to management.c)There is a correlation between underperforming firms and boards of directors who are notfully independent.d)All of the above are true, in the United States.Answer: d)International Finance in Practice: When Boards Are All in the Family20In the United States, it is well documented thata)Boards dominated by their chief executives are prone to troubleb)Public scrutiny can help improve corporate governancec)As public firms improve their corporate governance, the stock price goes upd)All of the aboveAnswer: d)Incentive Contracts21The board of directors may grant stock options to managers in order toa)save executive compensation costsb)use as a substitute for bonusc)align the interest of managers with that of shareholdersd)none of the aboveAnswer: c)22When designing an incentive contract,a)It is important for the board of directors to set up an independent compensation committeethat can carefully design the contract and diligently monitor manager’s actions.b)Senior executives can be trusted to not abuse incentive contracts by artificiallymanipulating accounting numbers since the auditors should look in to that.c)The presence of any incentive is enough, whether it is accounting based or stock-pricebased.d)The board of directors should always give the managers a “heads I win, tails you lose” typeof option.Answer: a)Concentrated Ownership23Concentrated ownership of a public companya)Is normal in the United States, following the well-publicized scandals of recent years.b)Is relatively rare in the United States and common in many other parts of the world.c)Leads to a free-rider problem with the minority shareholders relying on the majorityshareholders to assume an undue burden in monitoring the managementd)Is the norm in Great BritainAnswer: b)24Concentrated ownership of a public companya)Can be an effective way to alleviate the agency problem between shareholders andmanagers.b)Is the norm in Great Britainc)Tends to be an ineffective way to alleviate conflicts of interest between groups ofshareholdersd)None of the aboveAnswer: a)Accounting Transparency25Accounting Transparencya)Can only be achieved when managers commit to serving on their own audit committee.b)Occurs when the accounting department has translucent cubicles for their workersc)Promises to reduce the information asymmetry between corporate insiders and the public.d)None of the aboveAnswer: c)Debt26While debt can reduce agency costs between shareholders and managementa)Debt can create its own agency costsb)This only happens at extreme levels of debtc)This does not work for firms in mature industries with large cash reservesd)None of the above are true.Answer: a)27Debt can reduce agency costs between shareholders and management.a)But only if the firm is totally up to its eyeballs in debt.b)Only to the extent that the firm can commit all of its free cash flow.c)But excessive debt can create its own agency conflicts.d)Debt is best used as a corporate governance mechanism by young companies with limitedcash reserves.Answer: c)Overseas Stock Listings28Companies domiciled in countries with weak investor protection can reduce agency costs between shareholders and managementa)By moving to a better countyb)By listing their stocks in countries with strong investor protectionc)By voluntarily complying with the provisions of theU.S. Sarbanes-Oxley Actd)Having a press conference and promising to be nice to their investors.Answer: b)29Benetton, an Italian clothier, is listed on the New York Stock Exchange.a)This decision provides their shareholders with a higher degree of protection than isavailable in Italy.b)This decision can be a signal of the company’s commitment to shareholder rights.c)This may make investors both in Italy and abroad more willing to provide capital and toincrease the value of the pre-existing shares.d)All of the aboveAnswer: d)Market for Corporate Control30Suppose the managers of a company have driven the stock price down because they have spent the investors’ money on lavish perquisites like golf club memberships and great buckets of guacamole.a)This situation may prompt a corporate raider to buy up the shares of the firm in a hostiletakeover.b)If the hostile takeover is successful, the managers will probably lose their jobs in theensuing restructuring.c)If the restructuring is successful, the stock price should rise, and the corporate raider cansell his shares at a profit.d)All of the aboveAnswer: d)Law and Corporate Governance31Private benefits of corporate control will tend to be higher ina)French civil law countries than in English common law countriesb)English common law countries than in French civil law countriesc)French civil law countries than in Scandinavian civil law countriesd)English common law countries than in German civil law countriesAnswer: a)32English common law countries tend to provide a stronger protection of shareholder rights than French civil law countries becausea)the former countries tend to be more democratic than the latter.b)the former countries tend to protect property rights better than the latter.c)the former countries tend to have more separation of power than the latter.d)All of the above.Answer: b)33Studies show that the quality of law enforcement, as measured by the rule of law index, will tend to bea)Higher in French civil law countries than in English common law countriesb)Higher in English common law countries than in Scandinavian civil law countriesc)highest in Scandinavian civil law countries and German civil law countriesd)Highest in English common law countriesAnswer: c)Consequences of LawOwnership and Control Pattern34Suppose Mr. Lee and his relatives hold 30% of shares outstanding of Samsung Life, which in turn holds 20% of Samsung Electronics. What is the cash flow right of the Lee family in Samsung Electronics?a)50 percentb)10 percentc)20 percentd) 6 percentAnswer: d)Rationale: .30 × .20 = .0635Concentrated corporate ownership is most prevalent ina)Italyb)The U.K.c)The U.S.d)AustraliaAnswer: a)36In countries with concentrated ownershipa)Hostile takeovers are quite rareb)Hostile takeovers are quite commonc)All of the aboved)None of the aboveAnswer: a)37What is the difference between control rights and cash flow rights?a)Since all shareholders benefit only from pro-rata cash flows, control rights and cash flowrights are the same thing.b)Large investors may be able to derive private benefits from control, thus control rights canexceed cash flow rights.c)Cash flow rights are more important than control rights since the only reason to invest inanything is to generate cash.d)None of the aboveAnswer: b)Private Benefits of Control38One way to measure the value of private benefits of controla)Is to measure the difference in value between non voting shares and voting sharesb)Is to measure the value of the “block premium” the value difference between the price pershare paid for a control block of shares versus the exchange price of regular shares.c)Both a) and b)d)None of the aboveAnswer: c)Capital Markets and Valuation39Several studies document the empirical link betweena)Weak investor protection and GDP growthb)Financial development and economic growthc)Growth in GDP and concentrated ownershipd)None of the aboveAnswer: b)40Financial development can contribute to economic growth in what way(s)?a)Financial development enhances savingsb)Financial development channels savings toward real investments in productive capacitiesc)Financial development enhances the efficiency of investment allocation through themonitoring and signaling functions of capital markets.d)All of the above.Answer: d)Corporate Governance Reform41Comparing the U.S. with the German and Japanese corporate governance systems,a)The U.S. system is “market centered”.b)The German and Japan ese systems are “bank centered”.c)It seems fair to say that no country has a perfect system.d)All of the above.Answer: d)Objectives of Reform42Among the objectives of corporate governance reform,a)Introduce expensive and burdensome accounting reforms.b)Strengthen the protection of outside investors from expropriation by managers and controllinginsiders.c)Provide taxpayer financing for corporate raiders to strengthen the discipline of the marketplace.d)None of the aboveAnswer: b)43In the U.S., corporate governance reform has included all of the following except:a)Strengthen the independence of boards of directorsb)Enhancing the transparency and disclosure of financial statementsc)Energizing the regulatory an monitoring functions of the SECd)Requiring auditors to sit on the boards of directorsAnswer: d)Rationale: that would be a clear conflict of interest.44The Sarbanes-Oxley Act of 2002 stipulates thata) a public accounting oversight board be createdb)the company should appoint independent financial experts to its audit committeec)CEO and CFO sign off the company's financial statementsd)all of the aboveAnswer: d)45The Sarbanes-Oxley Act of 2002a)Has had the consequence that many foreign firms have de-listed in the U.S. exchanges and listedtheir shares on the London Stock Exchange and other European exchanges.b)Has increased the pace of foreign firms listing their shares in the U.S.c)a) and b) are both trued)all of the aboveAnswer: a)Students may enjoy arguing about the logical structure of this question, but clearly no one in their right mind would select c).46The cost of compliance with the Sarbanes-Oxley Act of 2002a)Is a small amount, since most firms were playing by rules to begin with.b)Disproportionately affects small firmsc)Is paid for with tax credits for firms found to be in compliance.d)all of the aboveAnswer: b)47The major components of the Sarbanes-Oxley Act include all of the following excepta)Accounting regulation—The creation of a public accounting oversight board charged withoverseeing the auditing of public companies, and restricting the consulting services that auditors can provide to clients.b)Audit committee—the company should appoint independent “financial experts” to its auditcommittee.c)Shareholder voting rights reform—“one share one vote” is now the law of the land.d)Executive responsibility—CEOs and CFOs must sign off on the company’s financial statements. Answer: c)Rationale: there are still many different classes of stock with varying voting rights.The Cadbury Code of Best Practice48The Cadbury Code of Best Practicea)Is the U.N. equivalent of the Sarbanes-Oxley Actb)Is voluntary, but firms that fail to comply must explain why they choose not to complyc)Has the force of law, like the Sarbanes-Oxley Actd)None of the aboveAnswer: b)49Following the adoption of the Cadbury Code of Best practice,a)Joint CEO/COB (chief executive officer and chairman of the board) positions declinedb)There has been a significant impact on the internal governance mechanisms of U.K. companiesc)CEOs have become more sensitive to company performance, strengthening managerialaccountability and weakening managerial entrenchment.d)All of the aboveAnswer: d)50The key requirements of the Cadbury Code of Best Practicea)Boards of directors should include at least three outside directorsb)The positions of CEO and chairman of the board should not reside in the same individualc)Compliance is mandatory for public corporations, optional for listed non-public corporationsd)a) and b) but not c)Answer: d)。