CFA Level I · CFA Level I Exam · Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits
A firm operates in a country with weak enforcement of laws and poor court systems. Relative to a firm in a strong legal environment, the firm's stakeholders are most likely to:
Stakeholders in a weak legal environment most likely rely more heavily on contractual and organizational protections. Since courts and regulators enforce rights poorly, they seek tighter contracts, collateral and governance mechanisms. Expropriation risk is higher and required returns are higher, so the other options reverse the effect.
- Arely more heavily on contractual and organizational protectionsCorrect
- Bface lower risk of expropriation by controlling insiders
- Crequire a lower return on capital supplied to the firm
Explanation
When legal enforcement is weak, stakeholders cannot depend on the courts, so they seek stronger contract terms, collateral and governance mechanisms. Expropriation risk is higher, not lower, and investors would demand higher, not lower, returns for the added risk.
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