Question

Which of the following actions are likely to reduce agency conflicts?

A Paying a large fixed salary to managers

B Placing restricting covenants in debt agreements

C Increasing the threat of corporate takeover

D All of the above statements are correct

Statements B and C are correct

2. Which of the following factors is likely to encourage a corporation to increase the proportion of debt in its capital structure?

A. An increase in the company’s degree of operating leverage

B The company’s assets become less liquid

C An increase in expected bankruptcy costs

D An increase in the corporate tax rates

3. Which of the follow is not a tool used to reduce the likelihood of a hostile takeover?

A Synchronized board elections

B Golden parachutes for board directors

C Poison pill

D Greenmail

4. According to Modigliani and Miller with no corporate taxations, …. Unlevered cost of equity is equal to?

A The levered cost of equity

B The cost of debt over tax

c The weighted-average cost of capital

d The risk-free rate

e None of the above

Answer 1

1: E: B&C are correct

HAving restrictive covenants in debt agreements reduces agency conflict since it requires agreement of shareholders. Increasing threat of takeovers reduces agency conflict between shareholders and managers since they have to be efficient to avoid such takeovers.

2: D: Increase in tax

(Taking on more debt reduces the cost of capital since it allows tax saving on interest. Higher the tax rate, higher is the tax saving and lower the cost of debt)

3:  Synchronized board elections

(Golden parachutes are benefits given to executives which will be lost in the event of hostile turnover. Poison pills make the share of the target company less attractive and hence avoids takeover. Greenmail is the practice of buying a voting stake in a company with the threat of takeover to force the target company to buy back the stake at a premium and avoid the takeover

Synchronized elections do not avoid hostile takeovers. I nfact staggered elections do.)

4: levered cost of equity

(Since there are no taxes, the unlevered cost of equity is the same as levered cost of equity since value of levered firm is sale as value of unelvered firm