Lecture 1

Question 1

Cooking the books meaning

Answer 1

Inflating value by recognizing revenues before they occur

Question 2

Types of corporations

Answer 2

Sole proprietorship - owner = firm, unlimited personal liability

Partnernship - all partners are liable for debt, unlimited liability

Limited liability comoanies - firm = legal entity with contractual rights and obligations, limited liabilities, seperate ownership and control (agency problems)

Question 3

Definition of corporate governance

Answer 3

Relationships between company, management, board and all stakeholders. Provides structure how to set objectives and how to attain them.

Question 4

Corporate governance quality affects:

Answer 4

-Firm value
-Shareholder rights

Question 5

Agency theory

Answer 5

Managers (agents) control the firm while shareholders (principals) own the firm

Question 6

Residual control rights

Answer 6

The right to make decisions in unforeseen situations, often held by managers. [company strategy, voting rights, management hire and fire]

Question 7

Main challenges for investors to ensure financial return

Answer 7

-Contract incompleteness (Can’t specify all possible details in the contract ex ante)
-Information asymmetry

Question 8

Bonding costs by the agent meaning

Answer 8

What the agent pays to show they’re reliable. “I promise I won’t mess up” fee

[Restricting their own freedom (e.g., signing a non-compete).
Agreeing to performance-based pay (e.g., stock options).]

Question 9

Residual losses

Answer 9

inevitable loss of value that remains even after you’ve spent on monitoring, incentives, and bonding. [manager still chooses a less risky project to protect their job, even though the riskier one could give higher returns.]

Question 10

Transaction (cost economics) theory

Answer 10

Organizing business in regards of outsourcing or producing parts in the most efficient way ( Firms exist to reduce the costs of transacting in the market.)

Question 11

Shareholder theory (Friedman)

Answer 11

Goal is to maximize shareholder value, while abiding laws and ethics

Question 12

Stakeholder theory (Freeman)

Answer 12

Organization’s effectiveness measured by ability to satisfy both shareholders AND stakeholders

Question 13

Stewardship theory

Answer 13

Managers are intrinsically motivated to act in the best interests of the corporation and its stakeholders. Trust instead of monitoring

Question 14

Institutional theory

Answer 14

Corporations are shaped by broader institutional environment