Concept Questions 1. Agency Problems Who owns a corporation? Describe the proces
ID: 2384044 • Letter: C
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Concept Questions 1. Agency Problems Who owns a corporation? Describe the process whereby the owners control the firm's management. What is the main reason that an agency relationship exists in the corporate form of organization? In this context, what kinds of problems can arise? 2. Not - for - Profit Firm Coals Suppose you were the financial manager of a not - for - profit business (a not - for - profit hospital, perhaps). What kinds of goals do you think would be appropriate? 3. Goal of the Firm Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short - term profits at the expense of long - term profits.Explanation / Answer
(1) a corporation is owned by its shareholders, who purchase ownership stock of the firm.
Most of the owners cannot be involved in routine operation of the firm. Therefore, they act as principals and hire agents who run the firm on behalf of the owners, to the best interests of the firm and of the owners. That way, the owners delegate their running the firm to the agents.
The agency relationship exists due to owners not being able to involve themselves with running the firm.
In this connection, however, a principal-agent problem arises. This represents a conflict of interest situation when, agents act to maximize their own benefits & interests, even if to the detriment of the owners. Hence, the goals of the owners & the goals of the agent are different and are in conflict. This problem is further aggravated by close proximity of agents to everyday operations of the firm, therefore gaining more information than the principals. It's called the information asymmetry, which is root cause of the principal agent problem.
(2) A not-for-profit (NFP) firm's objective is not to maximize profits. Instead, it aims at maximizing provision of services (or goods) that it offers so as to maximize reach to the intended beneficiaries. From financial perspective, for example, a suitable goal would be bed occupancy rate, instead of return on assets, when the manager looks at optimizing the efficiency ratio.
(3) This statement is partially incorrect (and partially correct). While a manager should not solely focus on current stock price and engage in myopic emphasis, he should not completely overlook the stock price, since it is an important indicator on the market tune about investor's assessment of the firm's performance and investor confidence. A declining stock price indicates lack of investor confidence, which should be analyzed to understand what erodes investor confidence. Otherwise, a declining stock price will reduce the firm's market capitalization.
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