Answers to Problem Set 1
Chapter 1
Concepts Review and Critical Thinking Questions
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers,
sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders
elect the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to
exist. Management may act in its own or someone else’s best interests, rather than those of the
shareholders. If such events occur, they may contradict the goal of maximizing the share price of the
equity of the firm.
13. 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.
14. We would expect agency problems to be less severe in countries with a relatively small percentage
of individual ownership. Fewer individual owners should reduce the number of diverse opinions
concerning corporate goals. The high percentage of institutional ownership might lead to a higher
degree of agreement between owners and managers on decisions concerning risky projects. In
addition, institutions may be better able to implement effective monitoring mechanisms on
managers than can individual owners, based on the institutions’ deeper resources and experiences
with their own management. The increase in institutional ownership of stock in the United States
and the growing activism of these large shareholder groups may lead to a reduction in agency
problems for U.S. corporations and a more efficient market for corporate control.
Chapter 1
Concepts Review and Critical Thinking Questions
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers,
sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders
elect the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to
exist. Management may act in its own or someone else’s best interests, rather than those of the
shareholders. If such events occur, they may contradict the goal of maximizing the share price of the
equity of the firm.
13. 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.
14. We would expect agency problems to be less severe in countries with a relatively small percentage
of individual ownership. Fewer individual owners should reduce the number of diverse opinions
concerning corporate goals. The high percentage of institutional ownership might lead to a higher
degree of agreement between owners and managers on decisions concerning risky projects. In
addition, institutions may be better able to implement effective monitoring mechanisms on
managers than can individual owners, based on the institutions’ deeper resources and experiences
with their own management. The increase in institutional ownership of stock in the United States
and the growing activism of these large shareholder groups may lead to a reduction in agency
problems for U.S. corporations and a more efficient market for corporate control.
