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Question 1:
Which of the following statements about legal and ethical issues is CORRECT?

There are many types of unethical business behavior. One example is when executives provide information
that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks,
but it is not illegal to provide it to stockholders.

Ethics is not an important consideration in business and in business schools.

If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the
stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who
participated in the fraud and the firm itself can be prosecuted.

If a lower level person in a firm does something illegal, like "cooking the books," to understate costs and
thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level
person cannot be prosecuted but the superior can be prosecuted.

Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are
not, and this is what determines ethical behavior in business.
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Question 2:
Imagine that a firm's board of directors wants to maximize value for all of its stockholders in general, as opposed to
some specific stockholders. A smart solution would be to design an executive compensation system that aims to build
the firm's long-term value.

True
False
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Question 3:
Which of the following statements about business organizations is CORRECT?

If a corporation elects to be taxed as a P corporation, then both it and its stockholders can avoid all federal
taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small
businesses.

It is generally easier to transfer one's ownership interest in a partnership than in a corporation.

It's unlikely for a firm to be organized as a corporation when it requires a lot of capital.
A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business
goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
Tax advantages of incorporation offset the corporate shareholders' exposure to unlimited liability.
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Question 4:
The board of directors is the highest ranking body in a corporation. The members of the board are elected by the
shareholders, and the chairperson of the board is the highest ranking member of the board. The CEO generally
reports to the board and its chairperson, and the board generally has the authority to remove the CEO.

True
False
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Question 5:
Maximizing the stock price on a specific target date will maximize shareholder value.

True

False
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Question 6:
Which of the following statements reflects the position of most people in business?

Whistleblowers are generally promoted more rapidly than other employees because of the courage it takes to
blow the whistle.
It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior.

A corporation's short-run profits will almost always increase if the firm takes actions that the government has
determined are in the best interests of the nation.
Firms and government agencies almost always agree with one another regarding the restrictions that should
be placed on hiring and firing employees.
Although people's moral characters are probably developed before they are admitted to a business school, it
is still useful for business schools to cover ethics, if only to give students an idea about the adverse
consequences of unethical behavior to themselves, their firms, and the nation.
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Question 7:
The Gabriel Corporation has asked you, a consultant, to recommend an action that is likely to reduce potential
conflicts between stockholders and bondholders. Which action do you propose?

A government regulation that banned the use of convertible bonds.

Compensating managers with more stock options and less cash income.

The firm begins to use only long-term debt (e.g., debt that matures in 30 years or more) rather than debt that
matures in less than one year.

The passage of laws that make it harder for hostile takeovers to succeed.

Including restrictive covenants in the company's bond indenture (which is the contract between the company
and its bondholders).
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Question 8:
Maximizing the firm's expected profits for the current year does not necessarily maximize the stockholders' wealth for
the current year.

True

False
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Question 9:
Which of the following statements accurately describes business organizations?

Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors
as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and
selling) of partnership interests.

In a limited partnership, the limited partners have voting control, while the general partner has operating
control over the business, and the limited partners are individually responsible, on a pro rata basis, for the
firm's debts in the event of bankruptcy.

A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be
paid by the partners rather than by the firm itself.
A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than
would a faster growing company.

In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's
investment in the business.
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Question 10:
Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between
stockholders and managers?

The company's outside marketing firm is given a lucrative year-by-year consulting contract with the company.

A firm's compensation system is changed so that managers receive larger cash salaries and no long-term
options to buy stock.
Congress passes a law that severely restricts hostile takeovers.

The company changes the way executive stock options are handled, with all options vesting after one year
rather than having 20% of the options awarded vest every two years over a 10-year period.
The composition of the board of directors is changed from all inside directors to all outside directors, and the
directors are compensated with stock rather than cash.
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Question 11:
In most corporations, the CFO is outranked by the CEO.

True

False
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Question 12:
Which of the following factors tend to encourage management to act in their stockholders' best interests?

Direct intervention by shareholders.

Firing managers who do not perform well.

A reasonable compensation package sufficient to attract and retain able managers.

Threat of a hostile takeover.

All of the above encourage management to act in stockholders' best interests.

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Question 13:
There are factors that influence stock price over which managers have virtually no control.

True

False
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Question 14:
Calistoga Combines is a publicly-owned firm. In order to best serve shareholders, its' primary operating goal should be
to:

Maximize the firm's expected EPS, which must also maximize the firm's price per share.

Use a well-structured managerial compensation package to reduce conflicts that may exist between
stockholders and managers.
Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock
price.

Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth.
Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to
attempt to maximize the current stock price than its intrinsic value.
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Question 15:
Which of the following represents a significant disadvantage to the corporate form of organization?

Difficulty in transferring ownership.

Exposure to taxation of corporate earnings and stockholder dividend income.

Degree of liability to which corporate owners and managers are exposed.

Level of difficulty corporations' face in obtaining large amounts of capital in financial markets.

All of the above are disadvantages to the corporate form of organization.

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Question 16:
The chairperson of the board and the CEO are one and the same.

True

False
 Question 11 

 Question 12 

 Question 13 

 Question 14 

 Question 15 

 Question 16 

 Question 17 

Imagine that you are the chairman of the board of a large corporation. Which of the following mechanisms do you
think the board should choose to adopt to motivate top-level managers to act in the best interests of
stockholders?

Take actions that reduce the possibility of a hostile takeover.

Eliminate a requirement that members of the board of directors have a substantial investment in the
firm's stock.

Elect a board of directors that allows managers greater freedom of action.

Decrease the use of restrictive covenants in bond agreements.

Increase the proportion of executive compensation that comes from stock options and reduce the
proportion that is paid as cash salaries.

Feedback: Incorrect. The goal of management should be to maximize long-run shareholder wealth, and paying
executives with stock and stock options can help reduce incentives for short-term performance.

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 Question 18 
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Question 18:
Which is TRUE about business organizations?

Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because
it is easier to set up and operate one of these forms rather than as a corporation. However, if the business
gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have
important tax advantages over proprietorships and partnerships.
Corporate stockholders are exposed to unlimited liability.

Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract
capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations'
less favorable tax treatment.
Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of international
businesses (in terms of the number of businesses) are organized as corporations, all governed by the same
legal statutes.
Large corporations are taxed more favorably than proprietorships.
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Question 19:
Bethany is planning to start a business. Why might she choose to operate her business as a corporation rather than as
a proprietorship or a partnership?

Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of
incorporation.

Corporate investors are exposed to unlimited liability.

Corporations generally face fewer regulations.

A smaller amount of a corporation's income is generally subject to federal taxes.

Corporations generally find it easier to raise large amounts of capital.

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Question 20:
The primary financial objective of the firm is to maximize EPS.

True

False
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Question 21:
If you sat on the board of directors of Tyng Corporation, which of the following actions would you recommend to
reduce potential conflicts of interest between Tyng's stockholders and bondholders?

The threat of hostile takeovers.

Financing risky projects with additional debt.

The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers'
actions.

Compensating managers with stock options.

Abolishing the Securities and Exchange Commission.

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Question 22:
Maximizing expected EPS will maximize shareholder value.

True

False
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Question 23:
Of the following actions, which one is most likely to reduce conflicts of interest between managers and stockholders?

Beef up the restrictive covenants in the firm's debt agreements.

Pay managers large cash salaries and give them no stock options.
Eliminate a requirement that members of the board of directors must hold a high percentage of their personal
wealth in the firm's stock.

For a firm that compensates managers with stock options, reduce the time before options are vested (i.e., the
time before options can be exercised and the shares that are received can be sold).

Change the corporation's formal documents to make it easier for outside investors to acquire a controlling
interest in the firm through a hostile takeover.
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Question 24:
Which of the following situations would most likely encourage a firm's managers to make decisions that are in the best
interests of stockholders?

The firm's founder, who is also the president and chairperson of the board, sells 85% of her shares.

The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover.

The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think
best without obtaining board approval.

The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds,
and hedge funds, rather than by small individual investors, rises from 10% to 80%.
The percentage of executive compensation that comes in the form of cash is increased and the percentage
coming from long-term stock options is reduced.