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True or False: Widely Held Stock, Institutional Investors

True or False. Please include a sentence or two of explanation.

1. The more widely held is the stock of a company the more likely is entrenched management to maximize its own self-interest rather than that of shareholders.

2. As the percentage of stock held by institutional investors increases, maximization of profit is more likely to occur than is the maximization of the self-interests of management.

3. The percentage of stock held by institutional investors is higher now than it was 40 years ago.

4. The power of institutional investors has lessened of late because of recent SEC decisions encouraging institutional investors not to "vote their stock."

5. The tendency toward vertical and horizontal integration by corporations (e.g. Steel and Auto Industries) is playing a greater role now than in the past.

6. Increasing the value of the firm is more likely to be successful once upper management makes decisions and it is then left to lower (operational) management to carry out the established plan with little monitoring.

7. The larger the impact the strategic plan, the less need there is for options / contingencies as the plan moves forward.

8. In determining the discounted cash flow for the corporate headquarters and the business units within the corporation, the same rates of discount should be used.

9. In order to determine the profitability and the DCF (discounted cash flow) of each business unit, all corporate costs must be allocated to the various business units.

10. At the present time, the tax benefits of using debt capital are considered as corporate headquarters benefits.

11. Forecasting cash flows in the last five years for major airlines has become easier than fifteen or twenty years ago.

12. Transfer prices used to minimize the corporate tax liability have no influence on the profitability and DCF of the business units.

13. Tax reducing transfer pricing to offshore units refers only to the shipping industry and has no relation to manufacturing activities.

14. The problem associated with allocating of costs increases when the various functions such as research and development are centralized as contrasted with a very decentralized organization.

15. The profit or loss from marketable securities should be allocated to the corporation's various business units.

16. The value of the corporate headquarters plus the value of the business units less the cost of debt capital equals the value of equity.

17. Being able to write off capital investments in the year the expenditures are made makes the traditional income statement and an adjusted cash flow statement even more diverse, number-wise.

18. For a corporation with minimal headquarters costs and great independence for business units, the value of the entire corporation should be closer to the sum of the values of the business units than it would be if the corporation was very centralized with only minimal independence of its business units.

19. The heavy importation of parts and products by American firms from mainland China is more due to lower labor costs and an artificially low price of Chinese currency than it is due to differential tax treatment in the two nations.

Solution Preview

See the attached file.

True or False

1. The more widely held is the stock of a company the more likely is entrenched management to maximize its own self-interest rather than that of shareholders.

True. Berle and Means (1932) found that there is an inverse relationship between the diffuseness of ownership and firm performance. As the ownership diffuse, the incentive / motivation for the small investors to control and correct the management of the company reduce as well as the resources available with the small investors to control the management reduce. This tilts the power in the hands of the management and hence they act more towards their self interest and less towards shareholders interests.

Berle, A. and Means, G. (1932), The Modern Corporation and Private Property, Harcourt, Brace & World, New York.

2. As the percentage of stock held by institutional investors increases, maximization of profit is more likely to occur than is the maximization of the self-interests of management.

True. Institutional shareholders perform a strong monitoring role on the managers. (Shleifer and Vishny 1986; Hartzell and Starks 2003). The institutional investors have both expertise and resources to monitor the management of the firm. When the institutional ownership is high, they have more incentives to devote their resources and expertise to monitoring which leads to maximization of profits rather than maximization of the self-interest of the management.

Shleifer, A. and Vishny, R. (1986) Large shareholders and corporate control, Journal of Political Economy, 94, 461-488
Hartzell, J. C. and Starks, L. T. (2003) Institutional investors and executive compensation, Journal of Finance, 58, 2351-2374

3. The percentage of stock held by institutional investors is higher now than it was 40 years ago.

True. There has been a steady rise in shareholding by institutions in advanced industrial countries. In US, the proportion of outstanding equity held by the institutional investors is more than 50% in major public corporations.

Nagarajan, A, Majumdar, S.K.(1997) The Impact of Changing Stock Ownership Patterns in the United States : Theoretical Implications and Some Evidence,
Journal of Industrial Economics, 82, 39-54

4. The power of institutional investors has lessened of late because of recent SEC decisions encouraging institutional investors not to "vote their stock."

False. Not exactly. The SEC decision to ...

Solution Summary

This solution correctly identifies the validity of the statements and touches on concepts such as widely held stock, institutional investors,discount rates, transfer prices and more.

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