Which of the following statements is CORRECT?

Question

BlackTom AI · Accepted Answer

First, let's restate the question and options to ensure clarity: Which of the following statements is CORRECT?

Option 1: In general, it is more in bondholders' interests than stockholders' interests for a firm to shift its investment focus away from safe, stable investments and into risky investments, especially those that primarily involve research and development.
Option 2: Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value as a result of poor management.
Option 3: The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.
Option 4: The managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers.
Option 5: Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value.

Option 1 analysis:
This statement asserts bondholders prefer shifting to riskier bets for higher returns. In reality, bondholders typically favor safety and predictable cash flows because they are creditors and rely on the firm’s ability to service debt. Increased risk can jeopardize debt service, so this claim is generally inaccurate and contrary to typical debt-holders’ interests.

Option 2 analysis:
This option claims that hostile takeovers occur when stock trades below intrinsic value due to poor management. The core idea is undervaluation signaling a potential target for raiders who believe they can unlock value through changes in management, capital structure, or strategic direction. This aligns with common corporate finance and takeover theory: undervalued firms are attractive targets for activists and raiders, especially if the market underreacts to the firm’s true potential.

Option 3 analysis:
Arguing that banning hostile takeovers would increase overall economic efficiency is controversial. Critics of takeovers argue that they may improve efficiency by replacing underperforming managers, while supporters claim they can destroy value through unnecessary debt, disruption, or misaligned incentives. Prohibiting takeovers could reduce market discipline and some dynamic efficiency, so the blanket claim of increased efficiency is not generally supported by consensus finance theory.

Option 4 analysis:
This statement notes that managers of established firms sometimes lobby to change rules to hinder raiders. It is plausible and historically observed: managers may seek regulatory protections or anti-takeover provisions to defend against unwanted takeover threats, making this claim reasonable and consistent with governance behavior in real markets.

Option 5 analysis:
The idea that stockholders are better off if managers withhold favorable news so the price stays below intrinsic value is misleading. Disclosure of favorable information generally increases stock prices and improves shareholder welfare by more accurately reflecting value. Deliberate withholding tends to misprice securities and harm investors, so this option is incorrect.

In summary, evaluating the statements against standard corporate finance and governance principles, options that claim bondholders prefer riskier investments (Option 1), or that banning takeovers would raise efficiency (Option 3), or that managers should conceal good news (Option 5) are inconsistent with established theories. The notion that hostile takeovers target undervalued firms (Option 2) is the stance that best matches typical explanations for why takeovers occur. Likewise, the idea that managers sometimes seek legislative protection against raiders (Option 4) reflects a common governance tactic observed in practice.

Which of the following statements is CORRECT?

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