Chapter 10 Corporate Governance True/False 1. Corporate governance is the set of mechanisms used to manage the relationship among stakeholders and to determine and control the strategic direction and performance of an organization. A. True B. False Answer: True 2. Corporate governance involves oversight in areas where owners, managers, and members of boards of directors may have conflicts of interest. A. True B. False Answer: True 3. Corporate governance is a means to establish harmony between parties (the firm's owners and its top-level managers) whose interests may conflict. A. True B. False Answer: True 4. In modern corporations—especially those in the United States and United Kingdom—a primary objective of corporate governance is to ensure that the interests of top-level managers are aligned with the interests of shareholders. A. True B. False Answer: True 5. Recent emphasis on corporate governance stems mainly from the failure of corporate governance mechanisms to adequately monitor and control top-level managers' decisions. A. True B. False Answer: True 6. The three internal corporate governance mechanisms are ownership concentration, board of directors, and the market for corporate control. A. True B. False Answer: False 7. Executive compensation is considered an external corporate governance mechanism because it determined in part by market forces. A. True B. False Answer: False 8. In the United States, the primary goal of a firm is to maximize profits to provide a financial gain to shareholders. A. True B. False Answer: True 9. In the United States, the members of the board of directors are a firm's key stakeholders and a company's legal owners. A. True B. False Answer: False 10. In the modern U.S. corporation, the ownership and managerial control of the firm are separated. A. True B. False Answer: True 11. In a large number of family owned firms, ownership and managerial control are not separated. A. True B. False Answer: True 12. 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. A. True B. False Answer: False 13. An agency relationship exists when one or more persons (the principal or principals) hire another person or persons (the agent or agents) as decision-making specialists to perform a service. A. True B. False Answer: True 14. The separation of ownership and control is the most effective means used by firms to prevent managerial opportunism. A. True B. False Answer: False 15. A top-level manager's reputation is a dependable predictor of his/her future behavior. A. True B. False Answer: False 16. As a rule, shareholders prefer more product diversification than do managers because shareholders wish to reduce risk and maximize wealth. A. True B. False Answer: False 17. Both top executives and owners of the firm wish to diversify the firm to reduce risk. A. True B. False Answer: False 18. Agency costs include incentives for executives, monitoring, enforcement costs, and any individual financial losses incurred by principals. A. True B. False Answer: True 19. In general, when governance mechanisms are strong, managers have free rein in their decisions. A. True B. False Answer: False 20. Failures of corporate internal controls and inadequate internal control systems allowed unethical executives at such companies as Enron and WorldCom to act in their own self-interest. A. True B. False Answer: True 21. The Dodd-Frank Wall Street Reform and Consumer Protection Act is the most sweeping set of financial and regulatory reforms in the United States since the Great Depression. A. True B. False Answer: True 22. The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions related to consumer protection, systemic risk oversight, capital requirements for banks, but not for executive compensation. A. True B. False Answer: False 23. While the implementation of the Sarbanes-Oxley Act in 2002 has been controversial to some, most believe that it has had positive results in terms of protecting stakeholders and certain stockholder interests. A. True B. False Answer: True 24. More intense application of governance mechanisms such as mandated by Sarbanes Oxley and Dodd-Frank may cause firms to take on fewer risky projects and thus increase potential shareholder wealth. A. True B. False Answer: False 25. Ownership of many modern corporations is now concentrated in the hands of institutional investors rather than individual stockholders. A. True B. False Answer: True 26. Large-block shareholders typically own at least 5 percent of a corporation's issued shares. A. True B. False Answer: True 27. Research evidence suggests that ownership concentration is associated with lower levels of firm diversification, which conforms to the interests of stockholders. A. True B. False Answer: False 28. In recent years, the number of individuals who are large-block shareholders have declined and been replaced by institutional owners such as mutual funds and pension funds. A. True B. False Answer: True 29. Institutional owners, despite their size, are usually unable to discipline ineffective top managers and cannot influence a firm's choice of strategies and overall strategic direction. A. True B. False Answer: False 30. Research suggests that institutional activism may not have a strong direct effect on firm performance but may indirectly influence the targeted firm's strategic decisions, including those concerned with international diversification and innovation. A. True B. False Answer: True 31. The primary role of the board of directors is to monitor and control top-level executives to protect owners' interests. A. True B. False Answer: True 32. Individual shareholders with small ownership percentages are less dependent on the board of directors to represent their interests than are large block shareholders. A. True B. False Answer: False 33. Because of recent ineffective performance, boards of directors are experiencing increasing pressure from shareholders, lawmakers, and regulators to be more effective in preventing managers from acting in their own interest. A. True B. False Answer: True 34. Generally, the board of directors can be classified as insiders, unrelated insiders, outsiders, and unrelated outsiders. A. True B. False Answer: False 35. Boards with many members from the firm's top management team tend to have weak monitoring and control systems for managerial decisions. A. True B. False Answer: True 36. DDD MetalWorks plans to go public in the next 2 years. In order to be listed on the New York Stock Exchange, the firm will need to restructure its present board of directors, which is made up of a majority outside independent directors to a board of directors that is dominated by insiders and related outsiders. A. True B. False Answer: False 37. Critics advocate reforms to ensure that independent outside directors represent a significant majority of the total membership of the board. But outsider-dominated boards may emphasize the use of financial as opposed to strategic controls. The risk of reliance on financial controls is that they may encourage managers to make decisions to maximize their interests and reduce their employment risk. A. True B. False Answer: True 38. A powerful CEO would oppose the appointment of a lead director on the board of directors. A. True B. False Answer: True 39. The separation of the positions of CEO and chairperson of the board of directors reduces the power of the CEO over firm governance practices. A. True B. False Answer: True 40. A board composed primarily of outside directors will have better insights as to the firms intended strategic initiatives, the reasons for the initiatives, and the outcomes expected from them than will inside directors. A. True B. False Answer: False 41. The performance of individual board members and entire boards are being evaluated more formally and with greater intensity than in years past. A. True B. False Answer: True 42. Because top management decisions are usually complex and nonroutine, determining the quality of executive performance is beyond the power of boards of directors. A. True B. False Answer: False 43. One of the changes to enhance the effectiveness of the board of directors is the creation of a "lead director" role that has strong powers with regard to the board agenda and oversight of nonmanagement board member activities. A. True B. False Answer: True 44. Executive compensation is a governance mechanism that seeks to align the interests of managers and owners through salaries, bonuses, and long-term incentive compensation such as stock awards and options. A. True B. False Answer: True 45. Long-term incentives facilitates the firm's efforts through the board of directors' pay-related decisions to avoid potential agency problems by linking managerial compensation to the wealth of common shareholders. A. True B. False Answer: True 46. The use of executive compensation as a governance mechanism is more challenging to firms implementing international strategies than those strictly operating domestically. A. True B. False Answer: True 47. 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. A. True B. False Answer: False 48. Well-designed stock option-based compensation plans should have the option strike prices substantially lower than the current stock prices. A. True B. False Answer: False 49. Stock option repricing where the strike price value of the option has been lowered from its original position sometimes happens when firm performance is poor. A. True B. False Answer: True 50. The market for corporate control is composed of individuals and firms that buy ownership positions or take over potentially undervalued corporations and make changes to those corporations, including the replacement of the top managers. A. True B. False Answer: True 51. For top-level managers, board acceptance of the acquiring firm's offer usually leads to job loss as the acquiring firms wants new leadership. If the offer is refused, however, the job loss risk is minimal. A. True B. False Answer: False 52. 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. A. True B. False Answer: False 53. The top management of RavenCrest, Inc. have significant stock options in RavenCrest. They are therefore more likely to gain in making an agreement to be acquired, especially if they have golden parachutes. A. True B. False Answer: True 54. The market for corporate control may not be as efficient as a governance device as theory suggests because takeover targets are not always low performers with weak governance. A. True B. False Answer: True 55. Hedge funds, as part of the market for corporate control, identifies a firm that is underperforming and then invests in it with the goal of improving that firm's performance. A. True B. False Answer: True 56. The increased use of the market for corporate control has decreased the sophistication and variety of managerial defense tactics that are used in takeovers. A. True B. False Answer: False 57. The most effective defense against a hostile takeover is the poison pill strategy. A. True B. False Answer: True 58. An advantage of severance packages is that they may encourage top-level managers to accept takeover bids that are attractive to shareholders. A. True B. False Answer: True 59. Awareness by top managers of the existence of external investors in the form of individuals (e.g., Carl Icahn) and groups (e.g., hedge funds) often positively influences them to align their interests with shareholders. A. True B. False Answer: True 60. As globalization grows, adequate corporate governance is becoming an important requirement for doing business with a foreign firms and in foreign countries. A. True B. False Answer: True 61. Foreign investors are playing a relatively minor role in the governance of firms in many countries. A. True B. False Answer: False 62. Large German firms must include employees, union members, and shareholders in the formal governance structure. A. True B. False Answer: True 63. Attitudes toward corporate governance in Japan are affected by the concepts of obligation, family, and consensus. A. True B. False Answer: True 64. The way that U.S. corporate boards of directors are presently structured, they have little influence on the unethical behavior of top management. A. True B. False Answer: False 65. If a stakeholder is dissatisfied with a firm, it will withdraw its support and give it to another firm. A. True B. False Answer: True 66. Corporate governance mechanisms are designed to ensure that top managers make strategic decisions that best serve the interests of the entire group of stakeholders. A. True B. False Answer: True 67. Ethically responsible companies design and use governance mechanisms that will at least minimally satisfy stakeholders' interests. A. True B. False Answer: True 68. Scandals at Enron, WorldCom, and HealthSouth illustrate the negative effects of poor ethical behavior on a firm's efforts to satisfy stakeholders. A. True B. False Answer: True Multiple Choice 69. Corporate governance is all of the following EXCEPT A. mechanisms used to determine and control the strategic direction and performance of organizations. B. a means to establish and maintain harmony between owners and top managers whose interests may conflict. C. ensuring that top managers' interests are aligned with the interests of stockholders. D. resolve conflicts among corporate employees. Answer: D 70. In the United States, the fundamental goal of business is to A. ensure customer satisfaction. B. maximize shareholder wealth. C. provide job security. D. generate profits. Answer: B 71. In the United States, a firm's key stakeholder(s) is(are) the A. government. B. executives. C. shareholders. D. customers. Answer: C 72. 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 Answer: D 73. Corporate governance revolves around the relationship between which two parties? A. shareholders and the board of directors B. shareholders and managers C. the board of directors and managers D. None of the these options are correct. Answer: B 74. Corporate governance is important to nations because A. shareholders want large stock returns. B. firms seek to invest in nations with national governance standards that are acceptable to them. C. company boards have lobbied for strong governance. D. the United States requires that other nations adopt its governance practices. Answer: B 75. 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. Answer: B 76. Complete the following: In small firms, managers often own a _________ percentage of the firm, which means there is separation between ownership and managerial control. A. small; small B. small; large C. large; small D. large; large Answer: C 77. The separation between firm ownership and management creates a(n) _________ relationship. A. governance B. control C. agency D. dependent Answer: C 78. 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. Answer: A 79. 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. Answer: C 80. Managers may decide to invest ______ in products that are not associated with the firm's current lines of business to increase the firm's level of diversification and decrease their employment risk. A. unsubstantial profits B. free cash flows C. marginal profits D. frozen assets Answer: B 81. Product diversification provides two benefits to managers that do not accrue to shareholders: _________ and _________. A. greater experience in a wider range of industries; lessening of managerial employment risk B. the manager frequently invests in the acquired firm, which allows him or her 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 Answer: D 82. 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. Answer: A 83. 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. Answer: B 84. A major conflict of interest between top executives and owners, is that top executives wish to diversify the firm in order to _________ , whereas 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 Answer: D 85. Compared to managers, shareholders prefer A. safer strategies with greater diversification for the firm. B. riskier strategies with more focused diversification for the firm. C. safer strategies with more focused diversification for the firm. D. riskier strategies with greater diversification for the firm. Answer: B 86. Agency costs reflect all of the following EXCEPT _________ costs. A. monitoring B. enforcement C. opportunity D. incentive Answer: C 87. All of the following are consequences of the Sarbanes-Oxley Act EXCEPT A. a decrease in foreign firms listing on U.S. stock exchanges. B. internal auditing scrutiny has improved and there is greater trust in financial reporting. C. an increased number of IPOs (initial public offerings) are expected. D. Section 404 creates excessive costs for firms. Answer: C 88. All of the following are areas covered by the Dodd-Frank Wall Street Reform and Consumer Protection Act EXCEPT A. consumer protection. B. CEO compensation. C. regulation of derivatives. D. retirement accounts. Answer: D 89. Broadly, the Dodd-Frank Wall Street Reform and Consumer Protection Act seeks to A. align financial institutions' actions with society's interests. B. increase the number of foreign firms listing on U.S. stock exchanges. C. require CEOs to attest to the accuracy of their companies' financial reports. D. increase consumer protection in pharmaceutical products. Answer: A 90. 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 Answer: A 91. Ownership concentration is determined by both A. the number of stockholders and the parties they represent. B. the number of stockholders and total percentage of shares they own. C. the number of outside directors and the parties they represent. D. the number of outside directors and total percentage of shares they own. Answer: B 92. As ownership of the corporation is diffused, shareholders' ability to monitor managerial decisions A. increases. B. decreases. C. remains constant. D. is eliminated. Answer: B 93. 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. financial institutions such as mutual funds and pension funds that control large-block shareholder positions. D. prevented by the Sarbanes-Oxley Act from owning more than 50 percent of the stock of any one firm. Answer: C 94. 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. challenges to the decisions of boards. C. focusing attention on ineffective boards of directors. D. a direct effect on firm performance. Answer: D 95. 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. Answer: B 96. Monitoring by shareholders is usually accomplished through A. management consultants. B. government auditors. C. the firm's top managers. D. the board of directors. Answer: D 97. 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. Corporate governance is best achieved with a board of directors with strong ties to management. Answer: D 98. Generally, a board member who is a source of information about a firm's day-to-day activities is classified as a(n) _________ director. A. lead independent B. inside C. related D. encumbered Answer: B 99. The New York Stock Exchange requires that the audit committee be A. available to comment to external analysts. B. headed by outside directors. C. liable for any illegal actions by the top management team. D. made up of CPAs with auditing experience. Answer: B 100. A virtually exclusive reliance on financial controls may occur when outsider-dominated boards exist. This may lead to all of the following EXCEPT A. high executive turnover. B. increased diversification of the firm. C. excessive management compensation. D. reduction in R&D expenditure. Answer: A 101. 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, he has been displaying a tendency toward personal extravagance at the firm's expense. In order to limit Mr. Leagreet's power, the 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. Answer: B 102. 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 2 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. Answer: C 103. 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 Answer: C 104. 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. Answer: A 105. 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. Answer: D 106. 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. Answer: C 107. The CEO and Chairman of the board of directors Alta Corp. is dismayed by a lack of effort and insights his directors provide during board meetings. The directors are all outsiders, experienced, and run their own successful firms. The CEO/chair genuinely seeks their greater involvement. What would you recommend? A. Requiring that the directors own stock in the company. B. Establishing a formal process to evaluate the board's performance. C. Electing an lead director. D. All of these options are correct. Answer: D 108. 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. Answer: D 109. The interests of multinational corporations' shareholders may be best served when there is A. a uniform compensation plan for all corporate executives, United States 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 executives of foreign subsidiaries. Answer: D 110. Managers in the United States receive _________ compensation than managers in the rest of the world. A. equivalent B. higher C. lower D. more variable Answer: B 111. 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 Answer: B 112. 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 (e.g., unpredictable economic, social, or legal changes). D. The compensation committee may not have comprehensive firm performance data. Answer: D 113. 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. Answer: B 114. 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 environment 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. Answer: A 115. 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 performance expectations. D. the top management team's interests and the owners' interests are aligned. Answer: B 116. Agricultural Chemicals, Inc., was the target of a hostile takeover 6 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. Answer: D 117. The market for corporate control may not be as efficient as previously thought as recent findings suggest 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. Answer: C 118. 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 Answer: C 119. 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 vary in their effectiveness as a defense to takeovers. D. defense tactics make the costs of a takeover lower. Answer: D 120. Ambrose Bierce, the CEO of DictionAry, has been paid a lump sum amounting to 3 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. Answer: A 121. The repurchase at a premium of the target firm's shares that were 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. Answer: A 122. A hostile takeover defense wherein the target firm makes its stock less attractive to a potential acquirer is called A. greenmail. B. a standstill agreement. C. crossing the palm with silver. D. a poison pill. Answer: D 123. Historically, _________ have been at the center of German corporate governance structure. A. banks B. institutional shareholders C. public pension funds D. government agencies Answer: A 124. 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. Answer: B 125. German executives are not dedicated to the maximization of shareholder value to the degree that is the case for executives in the UK and United States 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 and large institutional investors rarely have large ownership positions in firms. D. of the focus on stewardship-management in German firms rather than the financial performance focus of U.S. firms. Answer: C 126. Which of the following statements is about corporate governance in Germany is FALSE? A. The Vorstand (management board) of a German corporation makes decisions about strategy and management. B. The Vorstand is elected by the firm's employees. C. Employees, union members, and shareholders appoint members to the Aufsichsrat (the supervisory tier of the board). D. Large institutional investors such as pension funds, and insurance companies are relatively insignificant owners of corporate stock. Answer: B 127. 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. Answer: D 128. 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. Answer: D 129. _________ is an important influence in Japanese corporate governance structures. A. Innovation B. Consensus C. Competition D. Individualism Answer: B 130. Which of the following is TRUE of trends in Japan's corporate governance structure? A. Compensation of CEOs in both private and public companies is being tied more closely to observable performance goals. B. Increased regulation in the financial sector has increased the cost of mounting hostile takeovers. C. Banks' influence over corporations is increasing. D. The gap in compensation between CEOs in public and private companies is increasing. Answer: A 131. Which of the following is FALSE about corporate governance in China? A. The Chinese governance system may be tilting toward the Western model. B. With increasing frequency, the compensation of top executives of Chinese companies is closely related to prior and current financial performance of the firm. C. The state still uses direct and/or indirect controls to influence the strategies employed by most firms. D. Firms with higher state ownership tend to have lower market value and more volatility in those values over time. Answer: C 132. 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. Answer: B 133. 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. Answer: D 134. International Food Services (IFS) has a contract with the Marines to supply meals for its troops in Afghanistan 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 wrongdoing D. the head of contract services for the Marines Answer: B Essay 135. What is corporate governance and how is it used to monitor and control managers' decisions? Answer: 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. 136. Discuss the effect of the separation of ownership and control in the modern corporation. Answer: 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. 137. Define the agency relationship and managerial opportunism and discuss their strategic implications. Answer: 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). 138. Define the three internal corporate governance mechanisms and how they may be used to control and monitor managerial decisions. Answer: 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. 139. Discuss the difficulties in establishing performance-based compensation plans for executives. Answer: 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 underinvest 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. 140. Describe the market for corporate control and its implications for organizations. Answer: 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. 141. Briefly compare and contrast corporate governance in the United States, Germany, and Japan, and China. Answer: Corporate governance structures used in Germany and Japan differ from each other and from the ones used in the United States. 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 United States (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. Chinese corporate governance has become stronger in recent years. There has been a decline in equity held in state-owned enterprises, but the state still dominates the strategies employed by most firms. Firms with higher state ownership tend to have lower market value and more volatility in those values over time. In a broad sense, the Chinese governance system has been moving toward the Western model in recent years. For example, YCT International recently announced that it was strengthening its corporate governance with the establishment of an audit committee within its board of directors, and appointing three new independent directors. In addition, recent research shows that the compensation of top executives in Chinese companies is closely related to prior and current financial performance of the firm. 142. How does corporate governance foster ethical strategic decisions and how important is this to top-level executives? Answer: Governance mechanisms focus on the control of managerial decisions to ensure that the interest of shareholders, the most important stakeholder, will be served. But shareholders are just one stakeholder along with product market stakeholders (e.g., customers, suppliers, and host communities) and organizational stakeholders (e.g., managerial and nonmanagerial employees). These stakeholders are important as well. Therefore, at least the minimal interests or needs of all stakeholders must be satisfied through the firm's actions. Otherwise, dissatisfied stakeholders will withdraw their support from one firm and provide it to another (e.g., employees will exit and seek another employer, customers seek other vendors, etc.). Some believe that ethically responsible companies design and use governance mechanisms to ensure that the interests of all stakeholders are served. Top-level executives are monitored by the board of directors. All corporate stakeholders are vulnerable to unethical behaviors by the firm. If the image of the firm is tarnished, the image of customers, suppliers, shareholders, and board members is also tarnished. Top-level managers, as the agents who have been hired to make decisions that are in shareholders' best interests, are ultimately responsible for the development and support of an organizational culture that allows unethical decisions and behaviors. The board of directors has the power and responsibility to enforce this expectation. The decisions and actions of a corporation's board of directors can be an effective deterrent to unethical behaviors. The board has the power to hold top managers accountable for unethical actions as they can hire and fire these managers. Thus, the board of directors, which holds a position above the firm's highest-level managers, holds considerable power over top-level executives and can set and enforce standards for ethical behaviors within the organization. Subjective Short Answer 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. 143. (Refer to Case Scenario 1). What are the advantages and disadvantages of paying the new manager primarily cash pay? Answer: The best answers will note, assuming Ms. Diamond has an interest in seeing the store do well, that cash pay may let her focus on maximizing the level of service provided to the extant customer base. In terms of drawbacks, there is little incentive for Ms. Diamond to grow the business, which is what Mr. Wickersham is aiming for. 144. (Refer to Case Scenario 1). What are the advantages and disadvantages of paying the new manager primarily on new store sales growth? Answer: The best answers here will contrast the benefits of cash to incentive pay, and note that incentive pay will focus Ms. Diamond's efforts on increasing the customer base and the dollar sales per customer. A potential negative consequence would be for her to lose sight of customer service (retention), since she is working so hard to generate new sales. 145. (Refer to Case Scenario 1). What compensation structure would you recommend? Answer: 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 Ms.Diamond 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 Mr. Wickersham can establish a number of objectives for which the incentive pay can be earned. Such a balanced scorecard approach provides Ms. Diamond with the incentive to manage the whole store, and not one or two particular dimensions of it. Considering Abramson's Jewelers' focus on high-end products and relationship selling, I would recommend a compensation structure for Jill Diamond that includes a competitive base salary supplemented by performance-based incentives tied to sales and customer satisfaction metrics. This could include a commission structure based on sales volume and possibly profitability, ensuring alignment with the store's financial success and customer service standards. Additionally, offering long-term incentives such as profit-sharing or equity participation could further motivate Jill to drive business growth while maintaining the brand's reputation for quality and service. 146. (Refer to Case Scenario 1). The discussion of agency theory and executive compensation in the chapter suggest that the compensation system for Jill Diamond should be based on her ability to maximize shareholder wealth over the long term. Answer: True Case Scenario 2: Raptec. Raptec operates in three principal business segments: Direct Attached Storage ("DAS"), Storage Networking Solutions ("SNS"), and Software. These hardware and software products are found in high-performance networks, servers, workstations, and desktops from the world's leading OEMs, and are sold through distribution channels to Internet service providers, enterprises, and medium and small businesses and consumers. Since the time it went public, Raptec has experienced rapid growth and consistently profitable operations. In early 2002, Raptec announced its plan to spin-off the software segment, subsequently incorporated as Axio, Inc., in the form of a fully independent and separate company. Software was Raptec's most profitable and fastest growing segment. By mid- 2002 Raptec had completed the initial public offering of approximately 15 percent of Axio's stock, and then distributed the remaining Axio stock to Raptec's stockholders in a tax-free distribution. Axio's family of products includes category leaders in CD/DVD burning, digital photography, and digital video. Axio's new management team is composed of Lex Luthor, CEO, and previously the President of New Business Development for Universal Studios Recreation Group; Karal Kool, COO, and previously General Manager of Raptec's OEM Solutions Group; and R. Elliot Maxter, CFO, and previously corporate controller for Raptec. The interim four-member board of directors is currently comprised of Raptec senior officers, but the terms of the public offering require them to step down in 2 months. Thus, Axio will need to construct a new board, which in turn will be responsible for overseeing Axio's management and their compensation. 147. (Refer to Case Scenario 2). What characteristics will you look for in appointing new board members? Answer: The best answers will begin by noting that Axio should probably look outside the firm for new directors, to provide some balance of power and accountability. With this foundation, students can then debate what aspects of the firm would benefit most through external advice and counsel: legal, management consulting, finance, emerging markets, key customers, people with experience in rapidly growing firms, etc. These areas suggest the type of individuals and what experience and contacts should be sought out as new directors. 148. (Refer to Case Scenario 2). Develop arguments as to why and why not Lex Luthor should be appointed as chairperson of the new board. Answer: The case where a CEO also occupies the chairperson position (referred to as CEO duality) is common, but increasingly controversial. The best answers will note that there are certain trade-offs between this choice, and hence no easy answer. On the one hand, a CEO/chairperson may be able to execute strategies quicker given his or her added power and knowledge accrued from the role as CEO. Such nimble decisiveness may be very important for firms in fast cycle industries like software. On the other hand, duality dulls the clean distinction between ownership (through board representation) and managerial control, and increases managerial power and hence the threat of opportunistic behavior. 149. (Refer to Case Scenario 2). How should the board design the executive compensation scheme for Luthor, Kool, and Maxter? Answer: Most CEOs in fast-cycle industries also serve as chairperson. This means that the power balance and incentive alignment may have to be achieved through the level and structure of compensation. Regardless, speaking only to CEO compensation, the level of cash compensation would need to be set high enough to attract a talented manager. Students may also agree that the bulk of compensation should come in the form of bonuses, stock options, or other long-term incentive pay since such a structure will reward the CEO for increases in shareholder value. This is the essential objective of compensation, the alignment of executive and shareholder interests. The students should make the point that a compensation plan (such as bonuses and other incentive pay) that is based on short-term outcomes encourages the top managers to neglect the long-run welfare of the firm and its shareholders, and even to manipulate the company's financial results. 150. (Refer to Case Scenario 2). Raptec would enhance the effectiveness of its board if it appointed a "lead director" who would be responsible for the board agenda and oversight of nonmanagement board activities. Answer: True Test Bank for Strategic Management: Concepts and Cases: Competitiveness and Globalization Michael A. Hitt, R. Duane Ireland, Robert E. Hoskisson 9781285425177, 9780538753098, 9781133495239, 9780357033838, 9781305502208, 9781305502147
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