Untitled Deck

Question 1

What is the definition of Corporate Governance?

Answer 1

System of controls, incentives, and oversight to mitigate conflicts of interest

It aims to align managerial incentives with shareholder interests.

Question 2

What is the agency problem in corporate governance?

Answer 2

Managers (control) vs shareholders (ownership)

Managers may pursue self-interest, leading to conflicts with shareholder interests.

Question 3

What are the tools used to align managerial incentives with shareholder interests?

Answer 3

• Performance-based pay
• Equity ownership
• Monitoring

These tools help ensure managers act in the best interests of shareholders.

Question 4

What is the balance needed in corporate governance?

Answer 4

• Incentives
• Disciplinary mechanisms (board oversight, dismissal threat, takeover pressure)

This balance is crucial for effective governance.

Question 5

What are the limits of board oversight?

Answer 5

Costly to monitor managers; directors may lack incentives

Monitoring is often delegated to the board, which can limit effectiveness.

Question 6

What are the types of directors in a corporate board?

Answer 6

• Inside: employees/relatives
• Gray: business ties (e.g., bankers, lawyers)
• Outside/independent: no affiliations

Independent directors are best for shareholder protection.

Question 7

How does board independence affect corporate governance?

Answer 7

Independent boards are more effective in CEO dismissal & takeovers

Independence boosts stock prices but has a mixed effect on performance.

Question 8

What is the impact of board size on governance?

Answer 8

• Small boards: better governance, decision-making, accountability
• Large boards: coordination issues, groupthink, diluted accountability

Smaller boards tend to be more effective.

Question 9

What are some other monitors of corporate governance?

Answer 9

• Analysts: valuations, flag issues
• Lenders: enforce covenants
• Employees: whistleblowers
• Regulators: SEC (US), ASIC (Australia)

These entities help ensure accountability and oversight.

Question 10

What is the purpose of compensation policies in corporate governance?

Answer 10

Align manager pay with firm performance

Equity-based pay ties wealth to share price.

Question 11

What are the trends in CEO pay?

Answer 11

• Rose sharply in 1990s via options
• Higher pay-for-performance sensitivity

Trends indicate a growing link between pay and firm performance.

Question 12

What are the risks associated with equity-based pay?

Answer 12

• Option timing manipulation
• Backdating

These practices can indicate poor governance.

Question 13

What is the relationship between managerial ownership and agency conflict?

Answer 13

Higher ownership → fewer conflicts, but harder to dismiss managers

This creates a complex dynamic in governance.

Question 14

What actions can shareholders take to manage agency conflict?

Answer 14

• Propose resolutions
• Voting
• Activism

Shareholders can influence governance through various means.

Question 15

What is the two-strikes rule in Australia?

Answer 15

If 25%+ oppose exec pay report twice → board spill vote

This rule strengthens shareholder oversight on pay.

Question 16

What are entrenchment tactics used by managers?

Answer 16

• Poison pills
• Staggered boards

These tactics can shield managers from accountability.

Question 17

What is the role of takeover threats in corporate governance?

Answer 17

Hostile bids discipline managers

Regulatory frameworks like the Corporations Act 2001 provide oversight.

Question 18

What does the Corporations Act 2001 in Australia cover?

Answer 18

• Director duties
• Disclosure
• Takeovers
• Enforcement

This act is fundamental for corporate governance in Australia.

Question 19

What are the types of mergers?

Answer 19

• Horizontal Merger: same industry
• Vertical Merger: supplier or customer
• Conglomerate Merger: unrelated industries

Each type serves different strategic purposes.

Question 20

What are the methods of payment in mergers?

Answer 20

• Cash deal
• Stock swap

Transactions often involve combinations of cash, debt, or other securities.

Question 21

What is an acquisition premium?

Answer 21

Bidders usually pay more than the target’s market value

This premium reflects investor expectations.

Question 22

What are the reasons for takeovers?

Answer 22

• Realise operational or financial synergies
• Enhance efficiency or reduce costs
• Achieve strategic advantages

These motivations help justify paying a premium.

Question 23

What are economies of scale?

Answer 23

Cost savings from producing at larger volumes

Example: Stride Rite acquired Saucony to reduce manufacturing costs.

Question 24

What are economies of scope?

Answer 24

Savings from combining production, marketing, or distribution of related products

Example: Kraft’s acquisition of Cadbury expanded snack food distribution.

Question 25

What is **vertical integration**?

Answer 25

Merging firms at different stages of the same production process ## Footnote This can improve conditions across the value chain.

Question 26

What is the **Hubris Hypothesis**?

Answer 26

Managers act in good faith but misjudge outcomes ## Footnote This reflects overconfidence in their ability to create value.

Question 27

What is a **toehold** in the context of takeovers?

Answer 27

A minority stake (<10%) acquired before announcing a takeover bid ## Footnote This allows the acquirer to buy shares at a lower cost.

Question 28

What is a **poison pill**?

Answer 28

Defensive measure allowing existing shareholders to buy additional shares at a discount ## Footnote This dilutes the acquirer's stake and raises acquisition costs.

Question 29

What is a **staggered board**?

Answer 29

Only a fraction of directors are elected each year ## Footnote This prevents rapid board turnover and deters hostile bidders.

Question 30

What is the **free rider problem** in takeovers?

Answer 30

Need to offer close to full post-takeover value reduces acquirer's potential profit ## Footnote This can discourage acquisition attempts.

Question 31

What is the **Free Rider Problem** in the context of acquisitions?

Answer 31

The need to offer close to full post-takeover value reduces the acquirer's potential profit ## Footnote This is especially problematic in hostile takeovers where gaining full ownership is difficult.

Question 32

What is a **toehold** in acquisition strategy?

Answer 32

A minority stake (typically <10%) acquired before announcing a takeover bid ## Footnote It allows the acquirer to buy shares at the pre-announcement price, reducing average acquisition cost.

Question 33

List the benefits of acquiring a **toehold**.

Answer 33

* Sends a credible signal of intent * May provide voting rights for negotiation leverage or proxy fights * Can influence shareholder decisions or block defenses * Allows offering a lower price for remaining shares ## Footnote A toehold strengthens the acquirer's position in negotiations.

Question 34

How does a **toehold** impact the acquirer's share price?

Answer 34

* Positive if investors expect synergies or value creation * Negative if the deal seems costly or risky * Mitigates downside by lowering overall acquisition cost ## Footnote The final impact depends on market assessment of the takeover's strategic merits.

Question 35

What is a **Leveraged Buyout (LBO)**?

Answer 35

An acquisition strategy using significant debt financing, often led by private equity firms ## Footnote The acquirer contributes minimal equity and uses the target's assets and cash flows to secure and repay the debt.

Question 36

What are the key benefits of **LBOs**?

Answer 36

* Mitigate the free rider problem * Capture full value of improvements * Create financial discipline through heavy use of debt ## Footnote Gains accrue directly to the acquirer and investors, not dispersed across shareholders.

Question 37

What is a **freezeout merger**?

Answer 37

A merger that enables an acquirer to gain full control of a target by eliminating non-tendering shareholders ## Footnote It is especially suited to corporate acquirers seeking 100% ownership.

Question 38

What is the process of a **freezeout merger**?

Answer 38

* Begins with a tender offer (usually a small premium) * Secures majority of shares * Merges the target into a wholly owned entity ## Footnote Remaining shareholders are forced to accept the offer price and lose rights to post-merger gains.

Question 39

What is the impact of **competition** in the takeover market?

Answer 39

Most takeover gains still accrue to target shareholders ## Footnote A bid signals that the target is undervalued, attracting rival bidders and increasing the final acquisition price.

Question 40

Define a **financial option**.

Answer 40

A contract between a buyer (holds the right) and a seller (holds the obligation) ## Footnote The buyer pays a premium to the seller.

Question 41

What are the two main types of **options**?

Answer 41

* Call Option: Right to buy at the strike price * Put Option: Right to sell at the strike price ## Footnote The seller must fulfill the obligation if the buyer exercises the option.

Question 42

What is the **No-Arbitrage Principle**?

Answer 42

Prevents 'free lunch' opportunities in trading ## Footnote If violated, traders exploit until prices adjust.

Question 43

What is the **Put–Call Parity** formula?

Answer 43

C + PV(K) = P + S ## Footnote A call plus cash (strike PV) equals a put plus stock.

Question 44

What are **real options**?

Answer 44

Flexibility embedded in projects, not traded securities ## Footnote Value is to capture upside and limit downside.

Question 45

List the key **real options**.

Answer 45

* Option to Abandon * Option to Defer * Option to Expand * Option to Contract / Switch ## Footnote These options provide strategic flexibility in project management.

Question 46

What is the structure of a **decision tree**?

Answer 46

Nodes (decision = square; chance = circle) ## Footnote Assign payoffs at terminal nodes and work backwards to determine project value.

Question 47

What are the types of **leases**?

Answer 47

* Direct lease * Sale-and-leaseback * Operating lease * Finance lease * Sales-type lease * Leveraged lease ## Footnote Each type has different implications for ownership and risk.

Question 48

What is a **finance lease**?

Answer 48

Transfers risks & rewards to lessee, similar to debt ## Footnote It is a long-term lease where ownership may transfer at the end.

Question 49

What is the **breakeven lease payment**?

Answer 49

Payment that makes a firm indifferent between leasing and buying ## Footnote If actual lease payment is less than breakeven, the firm should lease; otherwise, buy.

Question 50

List the **valid reasons for leasing**.

Answer 50

* Efficiency gains * Risk sharing * Debt overhang * Agency problems * Adverse selection ## Footnote These reasons highlight the strategic benefits of leasing over buying.

Question 51

True or false: **Capital preservation** is a valid reason for leasing.

Answer 51

FALSE ## Footnote Capital preservation is just another form of debt and is not a valid reason for leasing.