2. Explain several dimensions of the shareholder-principal conflict with manageragents
known as the principal-agent problem. To mitigate agency problems between
senior executives and shareholders, should the compensation committee of
the board devote more to executive salary and bonus (cash compensation) or
more to long-term incentives? Why? What role does each type of pay play in
3. Corporate profitability declined by 20 percent from 2008 to 2009. What performance
percentage would you use to trigger executive bonuses for that year?
Why? What issues would arise with hiring and retaining the best managers?
6. In the context of the shareholder wealth-maximization model of a firm, what
is the expected impact of each of the following events on the value of the firm?
a. New foreign competitors enter the market.
b. Strict pollution control requirements are enacted.
c. A previously nonunion workforce votes to unionize.
d. The rate of inflation increases substantially.
e. A major technological breakthrough is achieved by the firm, reducing its
costs of production.
Exercises 1. For each of the determinants of demand in Equation 2.1, identify an example
illustrating the effect on the demand for hybrid gasoline-electric vehicles such as
the Toyota Prius. Then do the same for each of the determinants of supply in
Equation 2.2. In each instance, would equilibrium market price increase or decrease?
Consider substitutes such as plug-in hybrids, the Nissan Leaf and Chevy
Volt, and complements such as gasoline and lithium ion laptop computer
5. Two investments have the following expected returns (net present values) and
standard deviation of returns:
PROJECT EXPECTED RETURNS STANDARD DEVIATION
A $ 50,000 $ 40,000
B $250,000 $125,000
Which one is riskier? Why?
6. The manager of the aerospace division of General Aeronautics has estimated the
price it can charge for providing satellite launch services to commercial firms. Her
most optimistic estimate (a price not expected to be exceeded more than 10 percent
of the time) is $2 million. Her most pessimistic estimate (a lower price than
this one is not expected more than 10 percent of the time) is $1 million. The
expected value estimate is $1.5 million. The price distribution is believed to be
Chapter 2: Fundamental Economic Concepts 57
a. What is the expected price?
b. What is the standard deviation of the launch price?
c. What is the probability of receiving a price less than $1.2 million?