CHAPTER 2

REVIEW QUESTIONS

2. One of the conflicts that confront financial managers as an agent of the firm is,
probably, leadership conflict. It is not uncommon for every leader to have their own way of
leading a team. As in the case of financial managers, they may carry their responsibility through
executing a course of action which may or may not fit the real intent of the shareholders.
Shareholders may have a different choice of undertaking. No standard rules that indicate which
course of action should be followed by managers to achieve their goal thus, creating a conflict.
Another is the conflict of financial managers’ firm and social responsibility. Since based on the
owners’ perspective, the only appropriate goal is to maximize shareholders’ wealth while on the
other hand, the stakeholders’ perspective emphasizes social responsibility over profitability, the
decisions of the financial manager will not be based primarily on their immediate response to
shareholders’ wealth maximization but will end up considering both perspectives. Financial
managers owe the stockholders the very best decisions to protect and further stockholder
interests, but they also have a broader obligation to society as a whole. They may consider the
fact that maintaining some concern for social needs when pursuing the goal of maximizing the
wealth of the firm is a primary responsibility of the firm. Engaging in social responsibility
activities can be justified on the basis that these activities help to create an environment in
which the goal of the shareholders’ wealth maximization can be pursued easily.

Moreover, firms can attract the best managers through offering them lucrative share
option linked to their performance.

1. Stockholder wealth maximization is a long-term goal. It is a function of all “future”

returns to stockholders thus, management need not to focus merely on short-run impact.
Thus, choosing between the two actions, the second one is better – to keep the stock at
P1000 for several years but then increase it in five years. This action considers the long-run
impact on the firm and not just focusing on short-run or current period effects.
This happens when, for example, an enterprise made a large investment to upgrade its
technology. These improvements won’t have much effect on performance in the short-run
but are expected to reduce future costs significantly. Since they invested large amount,
their current earnings per share would decline due to increase of their expenses. Hence,
they may keep their stock prices as it is in the short-run as this is a part of making an
investment which has a long-term goal. As for its long-run impact, it triggers the increase
in demand for the firm’s stocks. Since there is an increase in demand, it causes the firm to
make an action of increasing the price of their stock.

8. a. Stockholders may have different views over this situation. Others may view this
as unnecessary disbursement of funds that should’ve been invested in order to generate
returns. They may think of this as an outflow of funds with no associated benefit at present or
even in some future time. On the other hand, others may view this positively. Although
adherence to social values may not produce the most efficient use of assets or the lower costs,
it will enhance the image of the firm. Although there may be conflict between promoting
socially responsible programs and the profit motive, maintaining some concern for social needs
when pursuing the goal of maximizing the wealth of the firm is a primary responsibility of a
firm. It might decrease the stock price in the short-run but will be offset in the long-run.
 b. Looking at the bigger view, shareholders may view this positively. If the
company’s operation will lead to higher profits and returns in the future compared to the
expected returns within that 4 years, it will be beneficial to the firm and its stock value,
considering the fact that earnings in that few years will be depressed. Similar to the above
action, it might decrease the stock price in the short-run but will be offset in the long-run.

c. Stockholders may view this shifting positively since investing the assets into a
form of common stock could increase rate of return. Thus, it positively affects the stock price.
However, this is only true if the firm has a competent financial manager who can make this
possible. If not, this shift will merely increase risks rather than return if not managed properly.

9. The firm’s goal, which is the maximization of shareholders’ value, is actually regarded as
a long-term goal. In this situation, the short-term effect of the upgrade in technology is
insignificant to the impact that will be generated in the near future. However, since they
invested large amount, their earnings per share would decline. This is due to increase of their
expenses causing the firm to have less fund.

Meanwhile, the intrinsic value of the firm may increase for the reason of positive future
perception of investors towards them which is brought by the upgrade in technology. This
triggers the increase in demand for the firm’s stocks. Since there is an increase in demand,
stock prices would go up.

MULTIPLE CHOICE
1. D
2. C
3. D
4. A
5. D