Corporate Governance & Financial Management 2 — Questions and Answers
Question 1: Which financial metric best measures a company's ability to generate cash from its core operations without capital expenditures?
- Free cash flow
- Operating cash flow (Correct answer)
- EBITDA
- Net income
Correct answer: Operating cash flow
Operating cash flow measures cash generated purely from core business operations before capital expenditures are deducted.
Question 2: A board's audit committee is reviewing an unusually large related-party transaction. What is the committee's PRIMARY governance responsibility?
- Approve the transaction immediately to avoid delays
- Ensure independent review and assess whether terms are arm's-length (Correct answer)
- Defer the decision to the CFO
- Report the transaction to shareholders without committee review
Correct answer: Ensure independent review and assess whether terms are arm's-length
The audit committee must independently assess related-party transactions to ensure they are conducted on arm's-length terms and do not disadvantage the company.
Question 3: Under the Sarbanes-Oxley Act Section 302, who must certify the accuracy of a public company's financial reports?
- The external auditor
- The audit committee chair
- The CEO and CFO (Correct answer)
- The board of directors collectively
Correct answer: The CEO and CFO
SOX Section 302 requires the CEO and CFO to personally certify the accuracy of financial statements filed with the SEC.
Question 4: A company's debt-to-equity ratio rises sharply over two quarters. From a governance perspective, what is the board's most important next step?
- Immediately halt all capital expenditures
- Review the company's capital structure policy and risk tolerance (Correct answer)
- Demand the CFO resign
- Increase dividend payments to reassure shareholders
Correct answer: Review the company's capital structure policy and risk tolerance
A rising debt-to-equity ratio signals increased financial leverage risk, requiring the board to evaluate whether the capital structure aligns with approved risk tolerance.
Question 5: Which concept describes the financial risk that arises when a company's fixed costs remain constant regardless of revenue fluctuations?
- Credit risk
- Operating leverage (Correct answer)
- Liquidity risk
- Currency risk
Correct answer: Operating leverage
Operating leverage refers to the amplification of profit changes relative to revenue changes due to high fixed costs.
Question 6: What is the primary purpose of a company's internal control over financial reporting (ICFR)?
- To maximize shareholder returns
- To ensure financial statements are reliable and free of material misstatement (Correct answer)
- To minimize the company's tax liability
- To replace the need for external audits
Correct answer: To ensure financial statements are reliable and free of material misstatement
ICFR is designed to provide reasonable assurance that financial reporting is accurate, complete, and free from material misstatement.
Question 7: A CFO proposes switching from LIFO to FIFO inventory accounting during a period of rising prices. What is the most likely governance concern?
- FIFO is prohibited under US GAAP
- The change could inflate reported earnings and may be motivated by short-term incentives (Correct answer)
- The switch will automatically trigger an SEC investigation
- LIFO produces higher tax benefits and should always be preferred
Correct answer: The change could inflate reported earnings and may be motivated by short-term incentives
Switching from LIFO to FIFO in inflationary periods increases reported earnings, raising concerns about whether management is manipulating results for compensation purposes.
Corporate Governance & Financial Management 2
Which financial metric best measures a company's ability to generate cash from its core operations without capital expenditures?