Corporate Governance And Ethics 5 — Questions and Answers
Question 1: The 'principal-agent problem' in corporate governance arises when:
- Shareholders disagree with each other on dividend policy
- Managers pursue their own interests at the expense of shareholders (Correct answer)
- The board lacks sufficient industry expertise
- Creditors demand higher interest rates than the company can afford
Correct answer: Managers pursue their own interests at the expense of shareholders
The principal-agent problem describes the conflict of interest that emerges when agents (managers) have incentives that diverge from those of principals (shareholders).
Question 2: Which of the following is an example of 'empire building' as an ethical concern in corporate governance?
- A CEO pursuing acquisitions primarily to increase their prestige and compensation rather than shareholder value (Correct answer)
- A board approving a rights issue to fund R&D expansion
- Management reinvesting all profits to fund organic growth
- A company acquiring a direct competitor to gain market share at fair value
Correct answer: A CEO pursuing acquisitions primarily to increase their prestige and compensation rather than shareholder value
Empire building occurs when executives pursue size-increasing strategies for personal gain (salary, status) rather than for genuine value creation for shareholders.
Question 3: Under SEC Regulation FD (Fair Disclosure), a public company is required to:
- File financial statements within 30 days of quarter end
- Simultaneously disclose material information to all investors if disclosed selectively (Correct answer)
- Obtain board approval before any investor communication
- Refrain from communicating with analysts outside of earnings calls
Correct answer: Simultaneously disclose material information to all investors if disclosed selectively
Regulation FD requires that if a company discloses material non-public information to certain investors, it must simultaneously (or promptly) disclose that information to all investors.
Question 4: A board that includes directors with diverse backgrounds in finance, law, technology, and industry is MOST likely to benefit from:
- Reduced decision-making speed due to disagreements
- Broader risk identification and more effective oversight (Correct answer)
- Lower director compensation requirements
- Easier compliance with SEC filing deadlines
Correct answer: Broader risk identification and more effective oversight
Cognitive and experiential diversity on a board improves risk oversight and decision quality by bringing multiple perspectives to complex strategic issues.
Question 5: The 'moral hazard' problem in executive compensation occurs when:
- Executives are paid below market rates
- Guaranteed bonuses reduce executives' incentive to manage risk prudently (Correct answer)
- Stock options are granted at above-market exercise prices
- Compensation disclosures are filed late with the SEC
Correct answer: Guaranteed bonuses reduce executives' incentive to manage risk prudently
Moral hazard arises when compensation structures (like guaranteed bonuses) insulate executives from downside risk, encouraging excessive risk-taking at shareholders' expense.
Question 6: Which of the following actions by an activist shareholder is MOST consistent with legitimate corporate governance engagement?
- Spreading false rumors to drive down share price before buying
- Filing a shareholder proposal to separate the CEO and Chair roles (Correct answer)
- Coordinating an undisclosed group purchase to cross a 5% ownership threshold
- Pressuring management to repurchase shares to boost short-term stock price before the activist exits
Correct answer: Filing a shareholder proposal to separate the CEO and Chair roles
Filing shareholder proposals on governance structure is a legitimate and legally protected form of shareholder engagement within SEC proxy rules.
Question 7: A company that adopts a 'long-term value creation' governance philosophy would MOST likely prioritize:
- Meeting quarterly earnings-per-share guidance at all costs
- Cutting R&D spending to improve near-term margins
- Investing in human capital, innovation, and sustainable practices (Correct answer)
- Maximizing share repurchases to reduce the float
Correct answer: Investing in human capital, innovation, and sustainable practices
Long-term value creation governance emphasizes investments in people, innovation, and sustainability over short-term financial metrics that can erode future competitiveness.
Corporate Governance And Ethics 5
The 'principal-agent problem' in corporate governance arises when: