Chapter 1

1. (CQ 1) Agency Problems Who owns a corporation? Describe the process whereby the
owners control the firm’s management. What is the main reason that an agency
relationship exists in the corporate form of organization? In this context, what kinds of
problems can arise?

- Shareholders own a corporation.

- The corporation comprises three sets of distinct interests: the shareholders (the
owners), the directors, and the corporation officers (the top management). The
shareholders control the corporation’s direction, policies, and activities. The
shareholders elect a board of directors, who in turn select top management. Members
of top management serve as corporate officers and manage the operations of the
corporation in the best interest of the shareholders.
- The relationship between stockholders and management is called an agency
relationship. Such a relationship exists whenever someone (the principal) hires another
(the agent) to represent his or her interests.
- Slide
2. (CQ 3) Goal of the Firm Evaluate the following statement: Managers should not focus
on the current stock value because doing so will lead to an overemphasis on short-term
profits at the expense of long-term profits.

False. Current stock value reflects the risk, timing, and magnitude of all future cash flows
in both short and long term.

3. (CQ 4) Ethics and Firm Goals Can the goal of maximizing the value of the stock
conflict with other goals, such as avoiding unethical or illegal behavior? In particular, do
you think subjects like customer and employee safety, the environment, and the general
good of society fit in this framework, or are they essentially ignored? Think of some
specific scenarios to illustrate your answer.

Goal of maximizing the value of stock definitely conflicts with other goals such as
avoiding unethical or illegal behavior. In a capital society, the appropriate goal of a
business firm is to maximize the value of stock.

4. (CQ 6) Agency Problems Suppose you own stock in a company. The current price per
share is $25. Another company has just announced that it wants to buy your company and
will pay $35 per share to acquire all the outstanding stock. Your company’s management
immediately begins fighting off this hostile bid. Is management acting in the
shareholders’ best interests? Why or why not?

The goal of management should be to maximize the share price for the current
shareholders. If management believes that it can improve the profitability of the firm so
that the share price will exceed $35, then they should fight the offer from the outside
company. If management believes that this bidder or other unidentified bidders will
 actually pay more than $35 per share to acquire the company, then they should still fight
the offer. However, if the current management cannot increase the value of the firm
beyond the bid price, and no other higher bids come in, then management is not acting in
the interests of the shareholders by fighting the offer. Since current managers often lose
their jobs when the corporation is acquired, poorly monitored managers have an incentive
to fight corporate takeovers in situations such as this.

5. (CQ 2) Not-for-Profit Firm Goals Suppose you were the financial manager of a not-for-
profit business (a not-for-profit hospital, perhaps). What kinds of goals do you think
would be appropriate?

Such organizations frequently pursue social or political missions, so many different goals
are conceivable. One goal that is often cited is revenue minimization; i.e., provide
whatever goods and services are offered at the lowest possible cost to society. A better
approach might be to observe that even a not-for-profit business has equity. Thus, one
answer is that the appropriate goal is to maximize the value of the equity.

6. (CQ 10) Goal of Financial Management Why is the goal of financial management to
maximize the current value of the company’s stock? In other words, why isn’t the goal to
maximize the future value?

Maximizing the current share price is the same as maximizing the future share price at
any future period. The value of a share of stock depends on all of the future cash flows of
company.