problemset2 - Matt Cantor Pam 334 Problem Set 2 Due Part 1...

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Matt Cantor Pam 334 – Problem Set 2 Due : October 12, 2007 Part 1 1. False – The business judgment rule is a legal doctrine that absolves managers from liability for poor results if the managers exercised “proper business judgment.” Thus, managers should not be held accountable if their business decisions result in negative effects if fraud was not committed. It is unlikely that the judges in courts are likely to be better at judging the prudence of business decisions than managers for a number of reasons. First, managers go through strict selection process in order to reach the level of their position. It is very unlikely that they are unqualified. In addition, unlike judges who hear a broad skew of cases, managers’ knowledge is specialized to the firm. There is also manager turn over if the managers don’t deliver what the board and stockholders desire, so it is in their best interest to make proper business decisions. However, it is very hard to remove a judge once he/she is appointed to the position. Generally, CEO compensation is tied to the performance of the firm through stock options - judges’ compensation is not. This is another reason why the BJR is more effective than court decisions. 2. Uncertain – Many times, hostile takeovers have significantly reduced agency costs. However, it is uncertain what the bidding firm will do once it takes control of the target firm. For example, if the bidding firm takes control and then the managers do not act in the best interests of the owners, then agency costs have not been reduced. On the other hand, if the managers from the bidding firm begin to help align the interests between the managers and the owners, then the hostile takeover can been seen as significantly reducing agency costs. As Jenson says, “When these costs (agency) are large, the threat or actuality of takeovers can reduce them”. Thus, they have the ability to reduce agency costs, but since each takeover is unique we cannot qualify that all takeovers will lead to a significant decrease in agency costs.
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