MGST 451 QUIZ 1 & 2 EXAM 70 QUESTIONS WITH
VERIFIED ANSWERS
a corporation is a legal business structure that establishes the business as being a
separate entity from the owners. - CORRECT ANSWER Lawyers
a corporation is a bundle of contracts - CORRECT ANSWER Economists
a mechanism established to allow different parties to contribute capital, expertise
and labor for their mutual benefit - CORRECT ANSWER Corporation
Sole proprietorships
Partnerships
Corporation - CORRECT ANSWER Type of corporations
1. Limited liability for investors
2. Transferability of investor ownership(Through the trading of shares of stock on
exchanges)
3. Legal personality(Has legal rights and obligations)
4. Separation of legal ownership and management control - CORRECT ANSWER
What are essential characteristics of public corporations?
1.Small firms' managers own large share of stock, which implies little separation
between ownership and management control
2. Historically, firms managed by founder-owners & descendants. - CORRECT
ANSWER Separation of Ownership and Control
,1. As they grow, they may not have access to all needed skills to manage the
growing firm and maximize its returns, so may need outsiders to improve
management
2. May need to seek outside capital (whereby they give up some ownership
control) - CORRECT ANSWER What issues these firms face
1. The thousands, or more, investors who own public corporations could not
collectively make the daily decisions needed to operate a business.
The shareholders elect directors to act as their agents in supervising the firm
The directors appoint officers (or executives) to actually run the firm on a day-to-
day basis
2. Problems arise in corporations because the agents (top management) are not
willing to bear responsibility for their decisions unless they own a substantial
amount of stock in the corporation - CORRECT ANSWER Separation of Ownership
and Control
1. "The directors of such companies, however, being the managers rather of other
people's money than of their own, it cannot well be expected that they should
watch over it with the same anxious vigilance with which the partners in a private
copartnery frequently watch over their own." ---- Adam Smith, The Wealth of
Nations 1776
2.No one spends other people's money as carefully as they spend their own. ---
Milton Friedman - CORRECT ANSWER The problem
1. Conflict of interests between principal and agent
, 2. Lack of trust on the good faith of agents
3. Different objectives:
Shareholders: Increase value of the firm
Managers: Own utility, e.g. nice offices, luxury car, empire building, avoid
unpopular decisions, etc.
4. Agency costs:
Monitoring the activities of agents is costly - hence, full monitoring is not optimal.
The value forgone due to imperfect optimal monitoring is an explicit agency cost -
CORRECT ANSWER Principal-agent problem
Agents are generally better informed than the principals. - CORRECT ANSWER
Both caused by information asymmetry.
Increases the likelihood of selecting inferior alternatives - CORRECT ANSWER
Adverse Selection
Increases the incentive of one party to take undue risks or shirk other
responsibilities
The costs incur to the another party - CORRECT ANSWER Moral Hazard
1. Resources remaining after the firm has invested in all projects that have positive
net present values within its current businesses
2. Available cash flows
Managerial inclination to overdiversify can be acted upon
VERIFIED ANSWERS
a corporation is a legal business structure that establishes the business as being a
separate entity from the owners. - CORRECT ANSWER Lawyers
a corporation is a bundle of contracts - CORRECT ANSWER Economists
a mechanism established to allow different parties to contribute capital, expertise
and labor for their mutual benefit - CORRECT ANSWER Corporation
Sole proprietorships
Partnerships
Corporation - CORRECT ANSWER Type of corporations
1. Limited liability for investors
2. Transferability of investor ownership(Through the trading of shares of stock on
exchanges)
3. Legal personality(Has legal rights and obligations)
4. Separation of legal ownership and management control - CORRECT ANSWER
What are essential characteristics of public corporations?
1.Small firms' managers own large share of stock, which implies little separation
between ownership and management control
2. Historically, firms managed by founder-owners & descendants. - CORRECT
ANSWER Separation of Ownership and Control
,1. As they grow, they may not have access to all needed skills to manage the
growing firm and maximize its returns, so may need outsiders to improve
management
2. May need to seek outside capital (whereby they give up some ownership
control) - CORRECT ANSWER What issues these firms face
1. The thousands, or more, investors who own public corporations could not
collectively make the daily decisions needed to operate a business.
The shareholders elect directors to act as their agents in supervising the firm
The directors appoint officers (or executives) to actually run the firm on a day-to-
day basis
2. Problems arise in corporations because the agents (top management) are not
willing to bear responsibility for their decisions unless they own a substantial
amount of stock in the corporation - CORRECT ANSWER Separation of Ownership
and Control
1. "The directors of such companies, however, being the managers rather of other
people's money than of their own, it cannot well be expected that they should
watch over it with the same anxious vigilance with which the partners in a private
copartnery frequently watch over their own." ---- Adam Smith, The Wealth of
Nations 1776
2.No one spends other people's money as carefully as they spend their own. ---
Milton Friedman - CORRECT ANSWER The problem
1. Conflict of interests between principal and agent
, 2. Lack of trust on the good faith of agents
3. Different objectives:
Shareholders: Increase value of the firm
Managers: Own utility, e.g. nice offices, luxury car, empire building, avoid
unpopular decisions, etc.
4. Agency costs:
Monitoring the activities of agents is costly - hence, full monitoring is not optimal.
The value forgone due to imperfect optimal monitoring is an explicit agency cost -
CORRECT ANSWER Principal-agent problem
Agents are generally better informed than the principals. - CORRECT ANSWER
Both caused by information asymmetry.
Increases the likelihood of selecting inferior alternatives - CORRECT ANSWER
Adverse Selection
Increases the incentive of one party to take undue risks or shirk other
responsibilities
The costs incur to the another party - CORRECT ANSWER Moral Hazard
1. Resources remaining after the firm has invested in all projects that have positive
net present values within its current businesses
2. Available cash flows
Managerial inclination to overdiversify can be acted upon
