Test: Reading Comprehension: Business - GMAT MCQ

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

Which of the following statements is supported by the information given in the passage?

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

The author’s primarily concerned with

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

The passage supports which of the following statements about disruptive innovations?

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following best describes the primary purpose of the author?

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following is supported by the information given in the passage?

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following is stated in the passage?

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

The author of the passage mentions a “big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time,” etc., in order to

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

The author is primarily concerned with

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

With which of the following statements would the author of the passage NOT agree?

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

Which of the following best illustrates an instance of successful unconscious pace-setting?

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Each of the following can be inferred from the passage EXCEPT

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

The author is primarily concerned with

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Which of the following is mentioned in the passage?

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Which of the following most aptly describes the function of the second paragraph?

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

Which of the following statements would the author most likely agree with?

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

The author is primarily concerned with

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

Which of the following CANNOT be inferred from the passage?