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Finance Examination Essay

2865 words - 12 pages

Finance Examination

Chapter 1
Discussion Questions and Solutions

3. In a corporation, what group has the ultimate responsibility for protecting and
managing stockholder’s interests?
A corporation’s top management has the ultimate responsibility of protecting and managing stockholder’s interests. There are essentially two groups responsible for protecting and managing the interests of stockholders being the Board of Directors and the top Management Team. However, the ultimately responsibility falls with the top management team, as they tend to be on hands-on in the daily operations of a business or a corporation. The top management team includes the Chief Executive Officer (CEO), ...view middle of the document...

Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely defined) between resource holders. An agency relationship arises whenever one or more individuals, called principals (business owners or shareholders), hire one or more other individuals, called agents (managers), to perform some service and then delegate decision-making authority to the agents. This means that agents are the managers of the company. The primary agency relationships in business are those
(a) Between stockholders (shareholders) and managers and
(b) Between debt holders and stockholders.
These relationships are not necessarily harmonious, thus agency theory is concerned with so-called agency conflicts, or conflicts of interest between agents and principals. This has implications for, among other things, corporate governance and business ethics. When agency exists it also tends to give rise to agency costs, which are expenses incurred in order to sustain an effective agency relationship (for instance, offering management performance bonuses to encourage managers to act in the shareholders' interests). Accordingly, agency theory has emerged as a dominant model in the financial economics literature, and is widely discussed in business ethics texts.
The theory of agency is important in public corporations because in privately owned firms, management and owners are usually the same people, and in public corporations on the other hand, it involves more than the owners to run the firm due to appointment of mangers. As a company moves from private to public ownership, management (or managers) now represents all the owners. This places management in the agency position of making decisions and acting on those decisions which should be in the best interests of all shareholders.
6. Why are institutional investors important in today's business world?
Institutional investor are large corporations, entities, group of individuals, companies, brokers, or financial investors who have a lot of financial might and ability as well as knowledge and expertise in running businesses. They usually invest by buying large stocks, buying companies, merging companies, or even establishing or expanding their own companies or business operations. The main reason institutional investors are important to the current business world is that they can have more clout than individual investors. Because they can own large blocks of stock in a corporation, hence they can exercise more influence in how they company is run. Moreover, institutional investors are generally more knowledgeable than individuals and have the resources to follow and understand what a business is doing. They bring liquidity to the company which in turn enhances the process of cash flow to the business.
7. Why is profit maximization, by itself, an inappropriate goal? What is meant by the goal
of maximization of shareholder’s wealth?
This is because of the fact that profit maximization is not...

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