Question 1

Much of our discussion this term focused on CEO compensation.

(a) Briefly describe the "ratchet effect" associated with the use of peer groups in setting compensation levels. Why is it a problem?

(b) Some people suggest that using stock options as compensation tends to encourage risk-taking behavior on the part of executives. Why might this be the case?

Question 2

(a) Describe what is meant by the phrase "earnings management" and briefly describe how it is measured.

(b) Is the tendency to engage in earnings management affected by corporate governance? If so, how?

Question 3

One potentially important characteristic of corporate directors is whether they are "independent." Based on our readings this term, does academic research find that independent directors are truly independent?

Question 4

Briefly describe the way in which creditors play a role in corporate governance. How does this role help to increase the value of the firm?

Question 5

Briefly describe the concept of "moral hazard" as it relates to corporations in the presence of government bailouts. Who realizes the benefits and who bears the cost of moral hazard? How can the costs of moral hazard be reduced through effective corporate governance?