Question

Stuck on the following questions. Multiple choice. One answer for each.

1. The primary goal of a publicly-owned firm interested in serving its stockholders should be to:

-Minimize the chances of losses

-Maximize share price

-Minimize expected EPS

-Minimize shareholder wealth

-Maximize expected total corporate profit

2. Which one of the following is an agency cost?

-Cost of dividend payments to stockholders

-Cost of interest payments to bondholders

-Cost of an internal audit required by bondholders

-Cost of wages for managers

-Cost of dividend payments to bondholders

Answer 1

1: Maximize share price

The main objective of the company is to maximize shareholder wealth. This is a long-term objective contrary to the objective of maximizing profits. Hence option 1 and 5 are incorrect. Minimizing expected EPS will result in reduction of shareholder wealth and is hence options 3 and 4 are incorrect.

2: Cost of wages for managers

Agency cost is a type of internal cost which comes due to the management acting on behalf of the shareholders. Payment of wages to the management is an agency cost since it is incurred due to the need of shareholders to have managers as their agents. The other costs are not agency costs since they would be incurred irrespective of whether managers are hired to act for the shareholders.