Blanton Corporation increased its financial leverage during 2010 ...

[yoooooman]

Blanton Corporation increased its financial leverage during 2010 by taking out a loan and using the proceeds to
  buy back common stock. At the end of 2010, the corporation reported higher earnings per share and higher
  return on equity.
 
  However, its stock price declined. Discuss why this may happen.

Question 2

Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the best interests of the owners, rather than in their self-interests.
 
  What strategies are available to shareholders to help ensure that managers are motivated to make decisions in the interest of shareholders?

[hramirez205]

Answer to Question 1

Financial leverage is a double-edged sword. While it may result in an increase in ROE and EPS, it may also increase
the riskiness of the company. Given the principal of a risk-return trade-off, the increase in return may not be sufficient
to offset the increase in risk, and the price may decrease. Also, stock prices are determined by many factors beyond
accounting information, such as competitors' actions, the level of interest rates, consumer confidence, etc. Therefore,
even if the financial leverage by itself had a positive impact on the stock price, other unidentified factors may have
caused the price to go down.

Answer to Question 2

Generally speaking shareholders may use the carrot of performance-based compensation such as bonuses or stock options whereby good performance by the firm results in higher compensation for managers. Stockholders also may use the stick of board of director oversight to monitor managers to make sure they are optimally fulfilling their responsibilities. There is also the market for corporate control where well-capitalized stockholders may take control of what they view as under-valued firms. Such outside forces should encourage managers to maximize firm value.