6. In most large corporations, ownership and management are separated. What are the main implications of this separation? Answer: The separation of the ownership and the management means that there exists a risk that the managers could act in such a direction that does not match the shareholders’ interest: an ‘agency problem’. For example, managers who are under the short-term contract would more focus on the short-term performance and are likely abandon a good opportunity that can help establish the foundation for a long-term growth which is crucial for the shareholders if the fruit cannot be realized before the end of their tenure. Also, managers may use the company’s resources for maximizing their personal benefits even though the cost is considerable enough to affect the profitability. Purchasing a jet plane for long distance transportation, purchasing the high-end office furniture and renting expensive office building with a spectacular view and so on can be a good example for that.
8. We can imagine the financial manager doing several things on behalf of the firm’s stockholders. For example, the manager might: a. Make shareholders as wealthy as possible by investing in real assets. b. Modify the firm’s investment plan to help shareholders achieve a particular time pattern of consumption. c. Choose high- or low-risk assets to match shareholders’ risk preferences. d. Help balance shareholders’ checkbooks.
But in well-functioning capital markets, shareholders will vote for only one of these goals. Which one? Why?
Answer: Shareholders’ biggest interest is to maximize their wealth. Especially when the capital market is functioning well, they don’t need to worry about the bankruptcy of the company nor the liquidity of the stocks they have, and thus, they are more likely to focus on increasing the profit. Achieving particular time pattern consumption, managing risks, and balancing the checkbooks can be accomplished by other ways than investing...
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