Economics: Private and Public Choice (MindTap Course List)
16th Edition
ISBN: 9781305506725
Author: James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher: Cengage Learning
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Chapter 21, Problem 4CQ
To determine
Principal agent problem.
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What is the principal-agent problem as it relates to corporate managers and stockholders? How did firms try to solve this problem in the 1990s? In what way did the “solution” backfire on some firms?
Answer question 35
You have two roommates who invest in the stock market.
a. One roommate says she buy shares only in companies that everyone believes will experience big increases in profits in the future. How do you suppose the price-earnings ratio of these companies compares to the price-earnings ratio of other companies? What might be the disadvantage of buying shares in these companies?
b. Another roommate says she only buys shares in companies that are cheap, which she measures by low price-earnings ratios. How do you suppose the earnings prospects of these companies compare to those of other companies? What might be the disadvantage of buying shares in these companies?
Chapter 21 Solutions
Economics: Private and Public Choice (MindTap Course List)
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- Can the principal agent problem be avoidedarrow_forwardDuring the early 2000's, energy giant Enron was shaken by financial mismanagement and scandal. It filed for bankruptcy and, after losing virtually all of it's customers, went out of business. What would have been the extent of stockholders' liabilities? Explain.arrow_forwardIn chapter 7, "Financial Markets," of the book Naked Economics, the author, Charles Wheelan, states, that, "...all financial instruments - no matter how complex the bells and whistles - are based on four simple needs." Which of the below is NOT of these "simple needs"? Raising Capital. Assumption of risk. Insuring Against Risk.arrow_forward
- Apple Corporation requires its top managers to own shares of stock in Apple equal in value to three times their annual salary. Explain what problem Apple is trying to solve with this requirement, and explain whether this requirement does indeed solve the problem.arrow_forwardWhat happens to interest rates in the market if the stock brokerage commission declines? Explain the reason for your answer!arrow_forwardConsider two firms (a) Firm A has profits twice as large as Firm B's profits. The firms do not differ in any other way. Which firm's stock should you buy if Firm A's stock price is PA = $50 and Firm B's stock price is PB = $30? What would you expect to happen to stock prices in equilibrium? Explain your answer (b) Suppose stock prices are in equilibrium. Explain what happens to the stock prices of these two firms if the interest rates increase? (c) Suppose stock prices are in equilibrium. Does the Efficient Market Hypothesis suggest to %3D buy one stock or the other stock? Explain.arrow_forward
- In 350 words or less Explain how Random Walk Theory makes it difficult for investors to make short run decisions. Create an example to illustrate this difficulty.arrow_forwardOn the golf course, John was playing near a group of four golfers. One of the four golfers was a director of Company ABC. The director was telling the three other golfers in his group that his company made much higher profits in the past year than in the previous year. When John went back to the office after the golf game, he checked with his broker regarding the stock and found that, two weeks earlier, the company had made an announcement similar to what the director had told his friends. John went ahead to buy the stock and was very pleased that the stock earned him abnormal returns over the next month. (i) Discuss the type of information that John heard on the golf course. Appraise which one (1) of the three forms of market efficiency is most relevant to this situation. (ii) Analyse and discuss whether the above situation describes a violation of the efficient markets hypothesis.arrow_forwardDiscuss how corporations can use equity financing by issuing stock through an investment banker. Describe the various securities markets in the United States.arrow_forward
- Explain briefly why stock prices are a leading economic indicator.arrow_forwardIndirect interlocks permit two board members of different corporations to sit on each other’s boards of directors.T or F?arrow_forwardScenario 14-3 Victor is the recipient of $1 million from a lawsuit. Victor decides to use the money to purchase a small business in Florida. His business operates in a perfectly competitive industry. If Victor would have invested the $1 million in a risk-free bond fund, he could have earned $100,000 each year. After he bought the small business, Victor quit his job as a market analyst with Research, Inc., where he used to earn $75,000 per year. Refer to Scenario 14-3. What is Victor's opportunity costs of operating his new business?arrow_forward
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