Eco 550 Check Your Understanding Week 1(Answers)
Each problem/question is worth 3 points. Please label your answers with the correct chapter and problem in the submission area.
• Chapter 1: Exercises 2, 3, and 6
• Chapter 2: Exercises 1, 5, and 6
Chapter 1: Exercises 2, 3, and 6
2.Shareholders want high long-term profits. Managers want job security and wonderful perks and amenities. Since risk and return tend to be positively related, managers may wish to avoid risks that shareholders want the managers to undertake. To encourage managers to take on risks, compensation committees can place a greater weight of their compensation on long-term incentives such as stock, options to buy stock, and bonus based on surpassing the performance of comparable firms over several years. When all of the compensation is cash (for salary and fringe benefits), mangers wish to start only low risk projects to avoid making any mistakes and stay away from higher risk, potentially high-valued projects.
3.When the bonus is tied to the short-run earnings of the manager’s firm, then the bonus declines even if the manager did everything he or she could do in the midst of an economic downturn. Accordingly, bonus pay should relate to the performance of other comparable companies for a longer period to remove any incentive to boost short-term cash flows at the expense of long-term profitability. The bonus is designed for mangers that exceed their industry averages over the last several years.
6.The following events will change shareholder wealth:
a. More competition is likely to lower prices and thereby reduce the value of the firm.
b. In general, higher costs on the firm is likely to lower the value of the firm. If these requirements are imposed equally on all firms, some of the cost burden will be borne by the firm and some by consumers, depending on the nature of the demand function. If the impact of the requirements is substantially different from one firm to another in an industry, the value of some firms may be
• Chapter 1: Exercises 2, 3, and 6
• Chapter 2: Exercises 1, 5, and 6
Chapter 1: Exercises 2, 3, and 6
2.Shareholders want high long-term profits. Managers want job security and wonderful perks and amenities. Since risk and return tend to be positively related, managers may wish to avoid risks that shareholders want the managers to undertake. To encourage managers to take on risks, compensation committees can place a greater weight of their compensation on long-term incentives such as stock, options to buy stock, and bonus based on surpassing the performance of comparable firms over several years. When all of the compensation is cash (for salary and fringe benefits), mangers wish to start only low risk projects to avoid making any mistakes and stay away from higher risk, potentially high-valued projects.
3.When the bonus is tied to the short-run earnings of the manager’s firm, then the bonus declines even if the manager did everything he or she could do in the midst of an economic downturn. Accordingly, bonus pay should relate to the performance of other comparable companies for a longer period to remove any incentive to boost short-term cash flows at the expense of long-term profitability. The bonus is designed for mangers that exceed their industry averages over the last several years.
6.The following events will change shareholder wealth:
a. More competition is likely to lower prices and thereby reduce the value of the firm.
b. In general, higher costs on the firm is likely to lower the value of the firm. If these requirements are imposed equally on all firms, some of the cost burden will be borne by the firm and some by consumers, depending on the nature of the demand function. If the impact of the requirements is substantially different from one firm to another in an industry, the value of some firms may be