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corp gov questions chapters 6-8

corp gov questions chapters 6-8 - Kevin Flinchbaugh...

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Kevin Flinchbaugh Business in Film Chapter 6 1. Describe how debt, in and of itself, might keep management in check? Fortunately debt, in and of itself, could be a governance mechanism. Because interest payments represent fixed obligations of the firm, debt actually imposes discipline on to the firm’s management. The firm’s management has to generate enough revenue to cover the firm’s interest expense. 2. Describe the efficacy/effect of financial institutions to be corporate monitors. Banks will of course monitor firms that they lend to. Getting a favorable interest rates from banks often entails the firm having to expose private information to prove that it is worthy of a low interest rate. The firm may have to agree to numerous covenants to get the favorable bank rate. 3. How are credit rating agencies important for firms, investors, and investment banks? Just as analysts help rate stocks for potential stock investors, credit rating agencies rate bonds for potential bond investors. With these ratings, credit rating agencies provide information to investors on the likelihood of a company making its required payments of interest and principal. Bond investors want to know whether the firm will be around for the 10 or more years the bonds are outstanding. Bondholders focus on safety. Most corporate bonds are given a safety rating by at least one of the credit rating agencies. 4. Why is the distinction between investment-grade and non-investment grade ratings so important? Bond ratings are required to sell too many investors. In 1936, the government expanded the role of credit ratings by requiring that commercial banks only hold high-quality debt. Banks could only own “investment-grade” bonds. Commercial banks need credit ratings on debt instruments in order to buy them, all bond issuers wanted to be rated. The credit rating helps investors understand the riskiness of a bond issue. 5. The SEC awards the Nationally Recognized Statistical Rating Organization designation. What criteria do they use to give the designation?
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To assess the credit worthiness of companies, the credit agencies employ financial analysts who examine the firms’ financial positions, business plans, and strategies. They review public financial statements issued by the companies. The SEC granted the agencies an exemption from disclosure rules so that companies can reveal nonpublic or sensitive information to the agencies in confidence. Companies have no obligation to reveal special information but they often do so to convince the agencies that their debt issues should be rated highly. They also question CEOs and other top executives directly when conducting reviews because of the importance of credit ratings. 6. How did the rating agencies fail Enron bondholders and creditors?
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