FINA 3332 EXAM 1 FULL REVISION NOTES
WITH TIME VALUE OF MONEY AND FINANCIAL
CONCEPTS
◉ Corporate managers work for the owners of the corporation.
Consequently, they should make decisions that are in the interests of
the owners,rather than in their own interests. What strategies are
available to shareholders to help ensure that managers are
motivated to act this way?
Answer: 1. Mount hostile takeovers.
2. Write contracts that ensure that the interests of the managers and
shareholders are closely aligned.
3. Ensure that employees are paid with company stock and/or stock
options.
4. Ensure that underperforming managers are fired.
◉ Recall the last time you ate at an expensive restaurant where you
paid the bill. Now think about the last time you ate at a similar
restaurant, but your parents paid the bill. Did you order more food
(or more expensive food) when your parents paid?
,Explain how this relates to the agency problem in corporations.
Answer: 1. The agency problem leads an individual (in your case)
and corporate managers (in the corporate setting) to put their own
self-interest ahead of the interests of the shareholders (your parents
in your case).
2. In both situations there may be a lack of interest in controlling
costs if those costs are not borne directly by the person making the
decision.
◉ Suppose you are considering renting an apartment. You, the
renter, can be viewed as an agent while the company that owns the
apartment can be viewed as the principal. What agency conflicts do
you anticipate? Suppose, instead, that you work for the apartment
company. What features would you put into the lease that would give
the renter incentives to take good care of the apartment?
Answer: The agent (renter) will not take the same care of the
apartment as the principal (owner), because the renter does not
share in the costs of fixing damages to the apartment. To mitigate
this problem, having the renter pay a deposit should motivate the
renter to keep damages to a minimum. The deposit forces the renter
to share in the costs of fixing any problems that are caused by the
renter. In addition, the provision in the lease for annual renewals
allows an incentive for a long-term renter* to maintain the leased
apartment.
, ◉ You're are the CEO of a company and you are considering entering
into an agreement to have your company buy another company. You
think the price might be too high, but you will be the CEO of the
combined, much larger company. You know that when the company
gets bigger, your pay and prestige will increase. What is the nature of
the agency conflict here and how is it related to ethical
considerations?
Answer: 1. There is an ethical dilemma when the CEO of a firm has
incentives that are opposite to those of the shareholders.
2. In this case, you (as the CEO) have an incentive to potentially
overpay for another company (which would be damaging to your
shareholders) because your pay and prestige will improve.
◉ What is the difference between a public and private corporation?
Answer: The shares of a public corporation are traded on an
exchange (or "over the counter" in an electronic trading system)
while the shares of a private corporation are not traded on a public
exchange.
◉ What is the difference between a primary and a secondary
market?
Answer: The primary market refers to a corporation issuing new
shares of stock and selling them to investors. After this initial
transaction between the corporation and investors, the shares
WITH TIME VALUE OF MONEY AND FINANCIAL
CONCEPTS
◉ Corporate managers work for the owners of the corporation.
Consequently, they should make decisions that are in the interests of
the owners,rather than in their own interests. What strategies are
available to shareholders to help ensure that managers are
motivated to act this way?
Answer: 1. Mount hostile takeovers.
2. Write contracts that ensure that the interests of the managers and
shareholders are closely aligned.
3. Ensure that employees are paid with company stock and/or stock
options.
4. Ensure that underperforming managers are fired.
◉ Recall the last time you ate at an expensive restaurant where you
paid the bill. Now think about the last time you ate at a similar
restaurant, but your parents paid the bill. Did you order more food
(or more expensive food) when your parents paid?
,Explain how this relates to the agency problem in corporations.
Answer: 1. The agency problem leads an individual (in your case)
and corporate managers (in the corporate setting) to put their own
self-interest ahead of the interests of the shareholders (your parents
in your case).
2. In both situations there may be a lack of interest in controlling
costs if those costs are not borne directly by the person making the
decision.
◉ Suppose you are considering renting an apartment. You, the
renter, can be viewed as an agent while the company that owns the
apartment can be viewed as the principal. What agency conflicts do
you anticipate? Suppose, instead, that you work for the apartment
company. What features would you put into the lease that would give
the renter incentives to take good care of the apartment?
Answer: The agent (renter) will not take the same care of the
apartment as the principal (owner), because the renter does not
share in the costs of fixing damages to the apartment. To mitigate
this problem, having the renter pay a deposit should motivate the
renter to keep damages to a minimum. The deposit forces the renter
to share in the costs of fixing any problems that are caused by the
renter. In addition, the provision in the lease for annual renewals
allows an incentive for a long-term renter* to maintain the leased
apartment.
, ◉ You're are the CEO of a company and you are considering entering
into an agreement to have your company buy another company. You
think the price might be too high, but you will be the CEO of the
combined, much larger company. You know that when the company
gets bigger, your pay and prestige will increase. What is the nature of
the agency conflict here and how is it related to ethical
considerations?
Answer: 1. There is an ethical dilemma when the CEO of a firm has
incentives that are opposite to those of the shareholders.
2. In this case, you (as the CEO) have an incentive to potentially
overpay for another company (which would be damaging to your
shareholders) because your pay and prestige will improve.
◉ What is the difference between a public and private corporation?
Answer: The shares of a public corporation are traded on an
exchange (or "over the counter" in an electronic trading system)
while the shares of a private corporation are not traded on a public
exchange.
◉ What is the difference between a primary and a secondary
market?
Answer: The primary market refers to a corporation issuing new
shares of stock and selling them to investors. After this initial
transaction between the corporation and investors, the shares
