COB 300B Test 1 Questions and Answers
100% Correct
Agency Problem occurs when? Correct Answ_there is a conflict of interest between the
managers and owners
• Problem solved when incentives for both parties lead to the same desired outcome
Agency Costs Correct Answ_extra costs incurred to solve the problem (i.e. to align the
incentives)
How can we get managers to do what shareholders want? Correct Answ_• Align incentives
• Shareholder's interests - increase wealth
• Managers - Set up a system that encourages them to act in a way that increases the stock value
• Compensation
• Tie management pay largely to value of the company
Optimal Executive Compensation Correct Answ_• There is debate:
,• Argument 1: Managers may not have full control of stock value
• Argument 2: Compensation with stock may encourage "cooking the books" and/or a short term
focus
Other ways to deal with the agency problem? Correct Answ_• Possibility of job loss
• Threat of hostile takeover
• Threat of termination
• Shareholders can accumulate enough votes to remove managers from their positions
Finacial system Correct Answ_Financial System: provides an environment in which
households (i.e. savers with extra money) can provide funds to businesses/governments/people
who need money.
Intermediaries Correct Answ_"Middlemen" like banks or stock exchanges that facilitate the
exchange of funds
Securities Correct Answ_tradeable/transferrable assets that are evidence of ownership or
indebtedness
, Equity Securities Correct Answ_Equity securities - represent ownership in a company (e.g.
common stock)
Debt Securities Correct Answ_Debt securities - represent indebtedness (e.g. bonds, loans)
Debt Correct Answ_Debt - represents borrowing (e.g. bonds, loans, mortgage)
-Must be repaid(Usually Principal + Interest)
Collateral Correct Answ_something pledged as security for repayment of a loan, to be
forfeited in the event of a default.
Covenants Correct Answ_Restrictions on what borrowers can do
Equity Characteristics Correct Answ_Represents ownership
- Doesn't need to be repaid
- Entitled to dividends
- Voting Rights
- Residual ownership- Payoffs after all other things are paid
100% Correct
Agency Problem occurs when? Correct Answ_there is a conflict of interest between the
managers and owners
• Problem solved when incentives for both parties lead to the same desired outcome
Agency Costs Correct Answ_extra costs incurred to solve the problem (i.e. to align the
incentives)
How can we get managers to do what shareholders want? Correct Answ_• Align incentives
• Shareholder's interests - increase wealth
• Managers - Set up a system that encourages them to act in a way that increases the stock value
• Compensation
• Tie management pay largely to value of the company
Optimal Executive Compensation Correct Answ_• There is debate:
,• Argument 1: Managers may not have full control of stock value
• Argument 2: Compensation with stock may encourage "cooking the books" and/or a short term
focus
Other ways to deal with the agency problem? Correct Answ_• Possibility of job loss
• Threat of hostile takeover
• Threat of termination
• Shareholders can accumulate enough votes to remove managers from their positions
Finacial system Correct Answ_Financial System: provides an environment in which
households (i.e. savers with extra money) can provide funds to businesses/governments/people
who need money.
Intermediaries Correct Answ_"Middlemen" like banks or stock exchanges that facilitate the
exchange of funds
Securities Correct Answ_tradeable/transferrable assets that are evidence of ownership or
indebtedness
, Equity Securities Correct Answ_Equity securities - represent ownership in a company (e.g.
common stock)
Debt Securities Correct Answ_Debt securities - represent indebtedness (e.g. bonds, loans)
Debt Correct Answ_Debt - represents borrowing (e.g. bonds, loans, mortgage)
-Must be repaid(Usually Principal + Interest)
Collateral Correct Answ_something pledged as security for repayment of a loan, to be
forfeited in the event of a default.
Covenants Correct Answ_Restrictions on what borrowers can do
Equity Characteristics Correct Answ_Represents ownership
- Doesn't need to be repaid
- Entitled to dividends
- Voting Rights
- Residual ownership- Payoffs after all other things are paid
