Section 14

Question 1

What can Agency cost of equity tell us?

Answer 1

it can be a signal of low profitability; can reduce effort of the manager (and thus affect value of firm)

Question 2

What can the agency cost of debt do?

Answer 2

induce risk shifting and inefficient project choice (thus reducing value of firm)

Question 3

define free cash flow?

Answer 3

cash flow in excess of that required to fund all projects that have positive net present values.

Question 4

Describe the theory developed that explains the benefits of debt in reducing agency costs of free cash flow:

Answer 4

how to motivate managers to disgorce cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies

Question 5

What does debt do to managers in regards to their ability to squander funds?

Answer 5

debt, and its periodic payments, reduces managers ability to squander funds on pet projects and “empire building”

Question 6

what is the lazy manager problem?

Answer 6

managers in stable firms with lots of free cash flow and without much product market competition may become lazy and complacent

Question 7

what does raising leverage do on managers in the lazy managers problem?

Answer 7

puts a lot of pressure on them to perform and make operations more efficient

Question 8

what do most leverage increasing transactions do after the fact to common stock prices, and which transactions are they?

Answer 8

stock repurchases, exchange of debt or preferred for common, debt for preferred : result in significantly positive increases in common stock prices.

Question 9

most leverage reducing transactions do what to common stock prices, and what are those transactions?

Answer 9

sale of common, exchange of common for debt/preferred, preffered for debt, call of convertible bonds, convertible preferred forcing conversion into common: result in significant decreases in stock prices

Question 10

from 1973 to 1970’s crude oil prices did what..?

Answer 10

increased tenfold

Question 11

what agency conflicts can excessive leverage produce?

Answer 11

risk shifting; managers have incentives to loot company prior to bankruptcy

Question 12

inefficiently managed firms are targets for…?

Answer 12

corporate raiders

Question 13

what is the market for corporate control?

Answer 13

the market for the right to control the management of corporate resources

Question 14

name the types of takeovers:

Answer 14

mergers, hostile and friendly tender offers, proxy contests, leveraged buyouts

Question 15

what is a merger?

Answer 15

bidder negotiates an agreement with target management on the terms of the offer for the target and then submits the proposed agreement to a vote with shareholders

Question 16

what is a tender offer?

Answer 16

bidder makes an offer directly to shareholders to buy some or all of the stock of the target firm

Question 17

what is a “Friendly” tender offer?

Answer 17

offers that are supported by target management

Question 18

what is a “hostile” tender offer?

Answer 18

refers to offers which are opposed by target managements

Question 19

what is a proxy contest?

Answer 19

dissident shareholder group attempts through a vote of shareholders to obtain control of the board of directors

Question 20

what are leveraged buyouts?

Answer 20

buyouts of shareholders equity, heavily financed with debt by a group that frequently includes incumbent management

Question 21

why are defensive strategies against hostile takeovers controversial?

Answer 21

they pose a conflict of interest for target management because they impose significant welfare losses on managers

Question 22

how can defensive strategies against hostile takeovers help target shareholders during a control contest?

Answer 22

litigation and other blocking actions may provide necessary time for the management of the firm to “shop” the target and negotiate competing bids

Question 23

what are some defensive measures against control contests?

Answer 23

litigation by target management, greenmail, poison pill

Question 24

define litigation by target management:

Answer 24

litigation against a hostile suitor based on charges of securities fraud, antitrust violations, and violations of state or federal tender offer regulations

Question 25

define greenmail:

Answer 25

targeted block stock repurchase - occurs when target management ends hostile takeover threat by repurchasing at a premium the hostile suitor’s block of target stock

Question 26

define poison pills

Answer 26

first introduced in 1982 and describes a family of shareholder rights agreements that, when triggered by an event such as a tender offer for control: provide target shareholders with rights to purchase additional shares or sell shares to the target at very attractive prices; makes hostile acquisitions exorbitantly expensive in most cases since the bidder has to buy much more shares

Question 27

what were some factors in the high level of takeover activity in the 1980’s?

Answer 27

changes in antitrust regulations, and deregulation

Question 28

describe the changes in antirturst regulations that led to takeovers in the 80’s?

Answer 28

antritrust regulators object less to vertical combinations. Even horizontal mergers between industry leaders were completely taboo before the 1980’s and are often allowed now

Question 29

Describe the deregulation that caused the takeover activity in the 1980’s

Answer 29

many of the mergers, takeovers, and restructuring over the last ten years have occurred in industries that recently were deregulated (transpiration, airlines, financial services, broadcasting, and oil/gas)

Question 30

returns to shareholders of acquiring companies are..?

Answer 30

typically low or even negative.

Question 31

returns to bidders and targets of takeovers…?

Answer 31

shareholders of target clearly benefit from takeovers because of high premiums

Question 32

Moeller et all (2005) showed that from 1991 to 2001, acquiring firms shareholders lost..?

Answer 32

$216 billion