Financial Management · Stakeholders and impact on corporate objectives

Agency Problem and Managing Managers' Goals in ACCA FM

Updated 11 October 2026 · Fact-checked

The agency problem is the conflict that arises when managers (agents) run a company for shareholders (principals) but pursue their own interests. You control it by monitoring managers, linking their pay to shareholder returns, and using share options and similar schemes to achieve goal congruence.

Understand Agency Problem and Managing Managers' Goals

Shareholders own a company, but they do not run it. They appoint directors and managers to act on their behalf. In agency theory the shareholders are the principals and the managers are the agents.

The problem is that agents have their own goals. Managers may want higher salaries, perks, job security, a bigger empire or a quiet life. Shareholders want their wealth maximised. When these goals differ, you have an agency conflict. The cost of the conflict, plus the cost of controlling it, is called the agency cost.

Typical symptoms are: managers avoiding risky but positive NPV projects to protect their jobs; managers taking on too much or too little risk; empire building through unprofitable acquisitions; holding excess cash; and focusing on short-term profit to hit bonus targets. Shareholders also have less information than managers. This is called information asymmetry.

Goal congruence is the aim: the managers' goals line up with the shareholders' goals. Agency conflict is the problem; goal congruence is the desired state. You reach congruence by reducing the conflict.

There are two broad ways to do it. First, monitor and constrain managers: audited accounts, an independent board, non-executive directors, audit and remuneration committees, analyst scrutiny, and the threat of takeover. Second, incentivise managers: pay linked to performance, such as bonuses on profit, EPS, ROCE or share price, and share option schemes. Each has costs and weaknesses, and the exam expects you to evaluate them.

Key rules to remember

Agency cost: Agency cost = cost of lost value from agent's own goals + cost of monitoring and incentives; A concept to state, not a calculation. Show both parts when you explain it.
Goal congruence: Manager's goals = shareholders' goal (maximise shareholder wealth); The target state. Do not confuse it with the conflict that stops it.
Share option value at exercise: Gain per option = market price at exercise − exercise price (if positive; otherwise zero); Options have no downside for the holder, which can encourage excess risk taking.
Shareholder wealth: Shareholder return = (P₁ − P₀ + dividend) ÷ P₀; A pay measure based on share price links managers to this return.

How to solve Agency Problem and Managing Managers' Goals questions

Use this method for any written or objective question on agency problems and managers' goals.

1Identify the principal and the agent. Usually shareholders and managers or directors.
2State the manager's likely self-interested goal in the scenario, such as job security, pay, or empire building.
3Explain the conflict with shareholder wealth maximisation and name the effect, for example avoiding risk or short-termism.
4Choose controls that fit: monitoring (audit, non-executives, committees, takeover threat) or incentives (bonuses, share options, long-term plans).
5Check that each incentive measure links to shareholder wealth, and note any flaw, such as manipulation or reward for luck.
6Evaluate: mention cost, fairness and the time period covered.
7Conclude with a clear recommendation or the main point the question asks for.

Quickest way: Problem, Control, Flaw

When to use it: Use it for Section A questions and for short written parts in Section C when you have little time.

Write the problem in one line: who is the agent and what do they want?
Name one control that matches it: monitor or incentivise.
Name one flaw of that control.
For multiple-choice questions, remove options that confuse goal congruence with the conflict or that describe a control that does not match the stated problem.

Common mistakes in Agency Problem and Managing Managers' Goals

Treating goal congruence and agency conflict as the same thing.
Both terms appear together in the same chapter.
Fix: Agency conflict is the divergence of goals. Goal congruence is when goals align. Controls aim to move you from conflict to congruence.
Saying share options always align managers with shareholders.
Textbooks stress the benefit and skip the drawbacks.
Fix: Add the flaws: options reward rising markets, not skill; the holder cannot lose, so may take excess risk; and managers may manipulate short-term share price.
Basing bonuses only on profit and calling it perfect.
Profit seems the obvious measure.
Fix: Profit can be boosted short term by cutting R&D or maintenance. Mention this short-termism and suggest long-term measures such as share price or multi-year targets.
Giving a list of controls without linking to the scenario.
Students recall a memorised list.
Fix: Match each control to the problem in the question. If the issue is risk aversion, suggest options. If it is perks, suggest monitoring.
Confusing the agency problem with conflict among other stakeholders.
Both sit under the stakeholders chapter.
Fix: Agency theory is about shareholders versus managers. Conflicts with lenders, employees or the government are separate stakeholder conflicts.

Worked examples

Example 1

A listed company's directors are paid a fixed salary. They reject a project with a positive NPV because it is risky and could cost them their jobs if it fails. Identify the agency problem and recommend one control.

Show the solution

Principals are the shareholders. Agents are the directors.
The directors' goal is job security. Shareholders want wealth maximised, which needs positive NPV projects accepted.
The conflict shows as excessive risk aversion. Value is lost, and this is an agency cost.
A fitting control is to link pay to shareholder returns, for example through a share option scheme, so directors gain when the share price rises.
A flaw: options give no downside, so directors may then take too much risk, and the share price may rise for reasons outside their control.

Answer: Risk-averse directors reject positive NPV projects, which conflicts with shareholder wealth maximisation. A share option or performance-linked pay scheme would encourage acceptance, but it may cause excessive risk taking and reward market movements.

Example 2

Directors hold options to buy 10,000 shares each at an exercise price of ₹200. At the exercise date the share price is ₹260. A different director would face a price of ₹180. Calculate each gain and comment on what this shows about incentives.

Show the solution

Director one: gain per option = ₹260 − ₹200 = ₹60.
Total gain = 10,000 × ₹60 = ₹6,00,000.
Director two: price ₹180 is below exercise price ₹200, so the option is not exercised and the gain is zero.
The holder cannot lose money from the option itself. The payoff is zero when the price falls but rises with price above ₹200.
This rewards share price growth, which aligns with shareholder wealth. But it has no downside, so it can encourage risk taking.

Answer: The first director gains ₹6,00,000. The second gains nothing, because options are not exercised below the exercise price. Options reward rising share price but give no penalty for a fall, so they may encourage risky decisions.

Exam tips

In Section C written answers, structure your points as problem, control, flaw. It shows evaluation and earns more marks than a bare list.
In objective test questions, read for the exact term. Goal congruence, agency cost and information asymmetry each have different meanings.
Always link the control to the scenario. If the question describes short-termism, say so and recommend longer-term measures.
Do not forget monitoring controls. Many students only discuss pay and lose marks for ignoring audit, non-executive directors and takeover threat.
Keep calculations of option gains simple: price at exercise minus exercise price, and zero if negative.

Practice questions from Stakeholders and impact on corporate objectives

Agency Problem and Managing Managers' 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 Managing Managers' Goals: frequently asked questions

What is the agency problem in ACCA FM?

It is the conflict between shareholders (principals) and managers (agents) when managers act in their own interest rather than maximising shareholder wealth. Examples are excessive perks, avoiding risk and empire building. The exam asks how to reduce it.

What is the difference between goal congruence and agency conflict?

Agency conflict is when managers' goals differ from shareholders' goals. Goal congruence is when they match. Controls such as monitoring and incentives aim to achieve congruence.

How do share options reduce the agency problem?

Options give managers a gain if the share price rises above the exercise price, so their reward links to shareholder wealth. They are imperfect, because they can reward luck, encourage excess risk and tempt managers to manipulate short-term share price.

Can the agency problem be removed completely?

No. Controls cost money and are imperfect, so some agency cost always remains. The aim is to balance the cost of controls against the value they protect.