Econ Study Plan for Exam 2 Solution
The three major types of firms in the United States are called
Sole proprietorships, partnerships, and
... [Show More] corporations
Limited liability means that
Shareholders in a corporation cannot lose more than their investment in the firm
The government grants limited liability to the owners of corporations
To limit shareholder risk and thus encourage investment in corporations
Limited liability becomes more important for firms trying to raise funds from a large number of investors, rather than from a small number of investors, because
Investors that make a small investment in a firm may be unwilling to risk all their personal assets if the firm fails
What do we mean by the separation of ownership from control in large corporations?
Shareholders own the corporation, but it is controlled by managers
How is the separation of ownership from control related to the principal-agent problem?
The agents (managers) may pursue their own interests rather than the interests of the principals (shareholders)
Suppose that shortly after graduating from college you decide to start your own business. Assuming you are starting a small business and want it to be your business a lone which category of firm are you most likely to start?
Sole proprietorship
An article discussing the reasons that the Connecticut state legislature passed a general incorporation law in 1873 observes that prior to the passage of the law, investors were afraid that large businesses "were not a safe bet for their money." The author argues that investors' fear was because prior to the passage of the law,
Owners of all businesses established in Connecticut had unlimited liability
I would like to invest in the stock market, but I think that buying shares of stock in a corporation is too risky. Suppose I buy $10,000 of Twitter stock, and the company ends up going bankrupt. Because as a stockholder, I'm part owner of the company, I might be responsible for paying hundreds of thousands of dollars of the company's debts. This statement is:
False because shareholders are not liable for the debts of a corporation
"Family-run companies ... could not raise sufficient capital to exploit the large-scale opportunities tied to the rise of the steam engine, notably railways and (with limited exceptions) global shipping and automated manufacturing." How did the United States solve the problem of firms raising enough funds to operate railroads and other large-scale businesses?
To help firms raise enough funds to operate railroads and other large-scale businesses, the United States
Passed general incorporation laws which limit the liability of owners in corporations
Two economists at the Brookings Institution argue that "new firms rather than existing ones have accounted for a disproportionate share of disruptive and thus highly productivity enhancing innovations in the past—the automobile, the airplane, the computer and personal computer, air conditioning, and Internet search, to name just a few."
New firms might be more likely than older firms to introduce "disruptive" innovations because new firms
May find it difficult to compete with the same types of goods and services already being produced by the larger, established firms
Assuming these economists are correct about the most important source of productivity enhancing innovations, the declining trend in the formation of new businesses implies that
The U.S. economy will become less dynamic and less able to sustain high rates of economic growth
An Associated Press article noted that some groups have filed lawsuits over what the groups describe as "overzealous licensing schemes, in occupations such as hair braiders, yoga teachers and casket makers."
Government licensing requirements would cause the rate of new businesses being formed to decrease
Given your answer to part (a), state and local governments pass these type of licensing requirements because
They are designed to insure the quality of service providers
The principal-agent problem arises almost everywhere in the business world—but it also crops up even closer to home, such as the case of the college classroom. In this case, who is the principal and who is the agent?
The principal is the student and the agent is the professor
.
The principal-agent problem in the public corporation between ownership and top management results from asymmetric information. All of the following are correct, except
This principal-agent problem can be prevented or reduced if the managers are allowed to have freedom in running the company
Sales personnel, whether selling life insurance, automobiles, or pharmaceuticals, typically get paid on commission instead of a straight hourly wage. The principal-agent problem between the owner of the business and its sales force is
Reduced when workers are paid on commission because it gives them an incentive to work harder
Private equity firms, such as Blackstone and Kohlberg Kravis Roberts & Co., search for firms where the managers appear not to be maximizing profits. A private equity firm can buy stock in these firms and have its employees elected to the firms' board of directors and may even acquire control of the targeted firm and replace the top management. Do private equity firms improve corporate governance?
Yes, private equity firms replace poorly performing managers with shareholder-friendly managers
For which of the following types of business organizations is there a legal distinction between the personal assets of the owners of the firm and the assets of the firm?
There is no limit to your liability
In the United States, ________ account for the majority of revenue earned and ________ account for the majority of business organizations.
Corporations; sole proprietorships
What term do economists use to refer to the conflict between the interests of shareholders and the interests of top management?
A principal-agent problem
Direct finance is borrowing via financial markets, while indirect finance is borrowing from financial intermediaries. If you borrow money from a bank to buy a new car, you are using indirect finance
A bond represents a loan to the company, while a share of stock represents part ownership of the company
.
The stock and bond markets provide information to businesses through changes in prices.
A decrease in the price of a firm's stock would tell managers which of the following?
Investors expect the firm to have lower profits in the future
A decrease in the price of a firm's bonds would tell managers which of the following?
The cost of external funds has increased.
Suppose that a firm in which you have invested is making a lot of moneymaking a lot of money. Would you rather own the firm's stock or the firm's bonds? Stock If losing a lot of money: bonds
Suppose you originally invested in a firm when it was large and profitable. Now the firm has downsized and is small and unprofitable. Would you be better off now if you had bought the firm's stock or the firm's bonds? Bonds
If you deposit $20,000 in a savings account at a bank, you might earn 3 percent interest per year. Someone who borrows $20,000 from a bank to buy a new car might have to pay an interest rate of 8 percent per year on the loan. Knowing this, why don't you just lend your money directly to the car buyer, cutting out the bank?
Since you would be loaning all of your savings to one borrower, it would be extremely risky
The shares of stock issued as a result of Twitter's Initial Public Offering (IPO) were sold in a primary market. The IPO is an example of direct finance.
According to an article in the Wall Street Journal, in May 2015, Moody's Investors Service cuts its rating on McDonald's bonds from A3 to A2. Source: Chelsey Dulaney, "Moody's Downgrades McDonald's, Following S&P and Fitch," Wall Street Journal, May 15, 2015. What is Moody's top bond rating? Aaa
Under what circumstances would Moody's, or the other bond rating agencies, be likely to cut the rating on a firm's bonds? None of the above
The likely result of this rating's cut will be
McDonald's will have to pay a higher interest rate when it sells bonds
Moody's, S&P and Fitch don't sell their services directly to investors because they argue that
Doing so creates a "free rider" problem
What impact would each of the following events be likely to have on the price of Google's stock? [Show Less]