Corporate Governance and Business Ethics

Question 1

What are four benefits of a public stock company?

Answer 1

1. Limited liability for investors
2. Transferability of ownership through stock
3. Legal personality with rights and obligations
4. Separation of legal ownership and management control

Question 2

What is the hierarchy of authority in a public stock company?

Answer 2

State charter → Shareholders → Board of Directors → Management → Employees

Question 3

What is the role of the Board of Directors?

Answer 3

A group elected by shareholders to oversee the company’s management and represent their interests.

Question 4

What is corporate governance?

Answer 4

Mechanisms to direct and control an enterprise, ensuring it pursues strategic goals successfully and legally.

Question 5

What problem does corporate governance attempt to address?

Answer 5

The principal-agent problem, where investors (principals) hire agents to perform work on their behalf.

Question 6

What is agency theory?

Answer 6

A theory viewing the firm as a nexus of legal contracts, resolving conflicts legally and designing tasks to minimize opportunism by agents.

Question 7

What causes adverse selection and moral hazard?

Answer 7

Information asymmetry between parties.

Question 8

What is adverse selection?

Answer 8

Increased likelihood of selecting inferior alternatives.

Question 9

What is moral hazard?

Answer 9

When one party is incentivized to take undue risks or shirk responsibilities, causing costs for the other party.

Question 10

What are the responsibilities of the Board of Directors?

Answer 10

Strategic oversight, CEO selection, executive compensation guidance, risk assessment, and ensuring compliance with laws.

Question 11

What is the role of the CEO in corporate governance?

Answer 11

The top manager who acts on behalf of the board and has authority to manage the company.

Question 12

What are governance mechanisms?

Answer 12

Tools to align incentives between principals (investors) and agents (managers).

Question 13

How does executive compensation align interests?

Answer 13

Stock options tie managers’ compensation to company performance, reducing information asymmetry.

Question 14

What is the average ratio of CEO to employee pay?

Answer 14

Approximately 300:1.

Question 15

What is the market for corporate control?

Answer 15

An external governance mechanism where activist investors seek control of underperforming companies.

Question 16

What is the role of auditors and regulations in corporate governance?

Answer 16

They align interests by ensuring accurate financial reporting and compliance with GAAP.

Question 17

What are Generally Accepted Accounting Principles (GAAP)?

Answer 17

Guidelines for public financial statements to ensure accuracy and consistency.

Question 18

What is the purpose of consulting and auditing?

Answer 18

To verify the accuracy of financial reports and ensure they are free from mistakes and misstatements.

Question 19

Who issues accounting principles?

Answer 19

Regulators, often at the government level or through international standards set by organizations like FASB.