Financial Management · Financial objectives and relationship with corporate strategy

Agency Problem and Aligning Management Goals in ACCA FM

Updated 11 October 2026 · Fact-checked

The agency problem arises when managers (agents) run a company for shareholders (principals) but pursue their own interests instead. You reduce it through goal congruence: link pay to shareholder wealth, use share options, apply corporate governance and monitor managers. Each remedy has costs and limits, and exam answers must say so.

Understand Agency Problem and Aligning Management Goals

A company is owned by shareholders but run by managers. Shareholders are the principals. Managers are their agents. The principals appoint the agents to act in the principals' interest, mainly to increase shareholder wealth.

The trouble is that managers have their own goals. They may want higher pay, job security, a bigger empire, perks, or a quiet life. This is the agency problem. Shareholders cannot watch every decision, and managers know more than shareholders do. This is called information asymmetry.

Typical symptoms: managers avoid risky but profitable projects to protect their jobs. They go for growth through acquisitions to raise their status and pay, even if value falls. They pay themselves large perks. They manipulate short-term profit to hit bonus targets. They may also retain cash rather than pay dividends. Another symptom is differing attitudes to risk. Shareholders can diversify, but managers' jobs depend on one firm.

The aim of the remedies is goal congruence: managers' goals line up with shareholders' goals. There are two broad routes. You can monitor managers (audit, reports, non-executive directors, institutional investors, governance codes). Or you can incentivise them (remuneration linked to performance, share options, bonuses). Both cost money. These costs are called agency costs. No scheme removes the problem fully.

In FM, expect to explain the problem, suggest remedies for a scenario, and evaluate how well they work. Always tie your answer back to shareholder wealth.

Key rules to remember

Agency relationship: Principal (shareholders) → appoints → Agent (managers); The agent should act in the principal's interest. Conflict arises when the agent's own goals differ.
Goal congruence: Manager's goals = shareholders' goals (wealth maximisation); Achieved by monitoring and by incentives. Never fully achieved.
Agency costs: Agency costs = monitoring costs + incentive costs + residual loss; Residual loss is the value still lost because managers' decisions are not perfectly aligned.
Share option value to manager: Gain per option = market price at exercise − exercise price (if positive); The option is worthless if the market price is at or below the exercise price on exercise.

How to solve Agency Problem and Aligning Management Goals questions

Use this method for any written or objective question on agency and management goals.

1Identify the principal and the agent in the scenario. Usually shareholders and directors or managers.
2State the conflict. Name the managers' own goal and how it differs from shareholder wealth maximisation.
3Spot the symptom in the scenario, such as risk avoidance, perks, short-termism or empire building.
4Choose remedies that fit the symptom. Split them into monitoring and incentives.
5Explain how each remedy works and link it to shareholder wealth, for example pay tied to share price or earnings.
6Evaluate: mention cost, manipulation risk, market-wide effects or short-term focus.
7Conclude with a recommendation, usually a balanced package, and say agency costs cannot be eliminated.

Quickest way: Problem – Remedy – Weakness

When to use it: Use for 2-mark objective questions and for planning a short written answer when time is tight.

Write P, R, W on your rough paper.
P: what is the manager doing that hurts shareholders?
R: match one remedy, either monitoring or an incentive.
W: give one weakness, such as cost, short-termism, or targets that can be manipulated.
For an objective question, pick the option that links the remedy directly to shareholder wealth.

Common mistakes in Agency Problem and Aligning Management Goals

Treating managers and shareholders as having the same goals.
Students memorise wealth maximisation and forget that managers are individuals with their own aims.
Fix: Always state the manager's own goal first, then show why it conflicts.
Listing remedies without linking them to the scenario.
Students recall a list from notes and write it out.
Fix: Match each remedy to a symptom in the question and explain how it changes behaviour.
Saying share options solve the problem completely.
Options look like a perfect link between pay and share price.
Fix: Mention drawbacks: share price can rise because of the market, not the manager; options may cause short-term focus or excess risk taking; options can be worthless if prices fall, reducing motivation.
Choosing profit-based bonuses and ignoring manipulation.
Profit seems like an obvious measure of success.
Fix: Note that profit can be boosted in the short term by cutting R&D or deferring costs, hurting long-term value. Suggest long-term or multiple measures.
Confusing the agency problem with conflicts between shareholders and other stakeholders.
Both topics sit in the same chapter.
Fix: Agency is about managers versus owners. Stakeholder conflict involves employees, lenders, customers and others.
Ignoring the costs of the remedies.
Students focus on benefits only.
Fix: Say that monitoring, audits, incentive schemes and governance all create agency costs that must be weighed against the benefit.

Worked examples

Example 1

Delta Co's directors have rejected a project with a positive NPV because it is risky and could cause losses that threaten their jobs. Explain the agency issue and recommend two ways to align the directors' goals with those of shareholders.

Show the solution

Principals are the shareholders. Agents are the directors.
Conflict: the directors prefer job security. Shareholders want all positive-NPV projects accepted to maximise wealth. Shareholders can diversify risk, but directors' careers depend on one company.
Remedy 1 (incentive): grant share options or shares that vest over several years, so directors gain when long-term value rises.
Remedy 2 (monitoring): appoint independent non-executive directors and a remuneration committee to review investment decisions and the risk appetite of the board.
Evaluation: options cost money and may reward market luck. Monitoring has costs and relies on independent directors being effective.
Conclusion: use a combination, and accept that some agency cost remains.

Answer: The directors act in their own interest by rejecting a positive-NPV project. Long-term share-based pay and independent board oversight reduce this, though both create costs and neither removes the conflict completely.

Example 2

A manager is granted 50,000 share options with an exercise price of ₹200. Explain the manager's gain if the share price on exercise is ₹260, and if it is ₹180. Comment on what this shows about options as a remedy.

Show the solution

Gain per option if price is ₹260: 260 − 200 = ₹60.
Total gain: 50,000 × ₹60 = ₹30,00,000.
If price is ₹180: the price is below the exercise price, so the manager would not exercise. The gain is ₹0.
Comment: the manager gains only if the share price rises above ₹200, so the manager is encouraged to increase shareholder wealth.
Weakness: the manager cannot lose money, so the option rewards upside but gives no downside penalty. This may encourage excessive risk taking. Also, a rising market may lift the price regardless of effort.

Answer: Gain is ₹30,00,000 at ₹260 and nil at ₹180. Options link pay to share price, but they do not fully align goals because managers share in gains and not in losses.

Exam tips

In written answers, name the principal and the agent in your first sentence. It earns marks and focuses your answer.
Always give both benefits and drawbacks of each remedy. Evaluation marks are often lost by one-sided answers.
Match the remedy to the scenario. If the problem is short-termism, suggest long-term vesting, not an annual profit bonus.
In objective questions, watch for the word 'agency costs'. They are the costs of monitoring and incentives, not simply managers' salaries.
Link back to shareholder wealth maximisation in your final sentence.

Practice questions from Financial objectives and relationship with corporate strategy

Agency Problem and Aligning Management Goals in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Agency Problem and Aligning Management Goals: frequently asked questions

What is the agency problem in ACCA FM?

It is the risk that managers, who run the company, act in their own interests rather than those of shareholders, who own it. It arises because managers have different goals and more information than shareholders. FM questions ask you to explain it and suggest ways to reduce it.

How can companies reduce the agency problem?

They can monitor managers through audits, independent non-executive directors, governance codes and institutional investor pressure. They can also use incentives such as performance-related pay, bonuses and share options. Each approach has costs, so a balanced package is usual.

What is goal congruence?

Goal congruence means that the goals of managers match the goals of shareholders, which is usually to maximise shareholder wealth. Companies try to achieve it through remuneration design and oversight. It is hard to achieve fully.

What are the drawbacks of share options?

Share prices can rise due to the market and not the manager's performance. Options give gains but no losses, so they may encourage excessive risk. They may also encourage short-term actions to lift the price before exercise.