Financial Management · The nature and purpose of financial management

Agency Problem and Stakeholder Conflicts 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 goals instead. Shareholders reduce it through monitoring, contracts and incentives such as bonuses, share options and LTIPs, so that managers' interests become congruent with theirs. Other stakeholders can also conflict with shareholders.

Understand Agency Problem and Stakeholder Conflicts

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

The agency problem is that managers may not do this. They may care more about their own pay, job security, status or power. Examples: building an empire through poor acquisitions, avoiding risk to protect their jobs, taking excessive perks, or choosing short-term profit to earn a bonus. Managers also know more about the business than shareholders do. This is called information asymmetry.

Agency costs are the costs of this problem. They include the cost of monitoring managers (audit, reports, non-executive directors), the cost of bonding and incentive schemes, and the loss when managers still make poor decisions. Goal congruence means the aims of managers and shareholders line up.

There are two broad ways to align interests. First, monitoring and control: external audit, corporate governance codes, non-executive directors, an audit committee, and analysts and the threat of takeover. Second, incentives: performance-related pay tied to profit, earnings per share, share price or total shareholder return, executive share options and long-term incentive plans (LTIPs). Each has problems. Profit-based bonuses encourage short-termism and creative accounting. Share options reward share price rises that may come from the market, not from effort. They can also encourage excessive risk taking, because options lose nothing if the price falls.

Other stakeholders also have conflicts with shareholders. Shareholders and lenders: shareholders may prefer risky projects or high dividends, while lenders want safety and may add covenants. Shareholders and employees: pay and job security against profit. Shareholders and customers or suppliers: price and quality against margin. Shareholders and government or the community: tax, regulation and environmental impact against cost. Managers must balance these, but the main financial objective remains shareholder wealth.

Key rules to remember

Agency relationship: Principal (shareholders) → appoints → Agent (managers); The agent acts for the principal. Conflict arises when the agent's goals differ from the principal's.
Agency costs: Agency costs = monitoring costs + bonding/incentive costs + residual loss; Residual loss is the value lost when managers still act against shareholders' interests.
Goal congruence: Manager's aims = shareholders' aims; The aim of remuneration and governance design. It is never perfect.
Total shareholder return (TSR): TSR = (P₁ − P₀ + D) ÷ P₀; P₀ is opening share price, P₁ closing price, D dividends in the period. Often used as a performance measure for incentives.

How to solve Agency Problem and Stakeholder Conflicts questions

Use this method for narrative questions and for scenarios asking you to explain a conflict or recommend a remuneration scheme.

1Identify the principals and agents, and the stakeholder groups in the scenario.
2State the conflict: what the manager or group wants against what shareholders want. Use facts from the scenario.
3Explain the harm: link it to shareholder wealth or to agency costs.
4Propose solutions: monitoring and governance, and incentives such as bonuses, share options or LTIPs.
5For each solution, apply it to the scenario and link it to a measure such as EPS, share price or TSR.
6Evaluate: give at least one weakness, such as short-termism, risk taking, manipulation or high cost.
7Conclude with a clear recommendation that fits the question requirement.

Quickest way: Conflict, cost, cure, catch

When to use it: Use for short written parts and for objective test questions on agency or stakeholder conflict.

Conflict: who wants what?
Cost: how does it reduce shareholder wealth?
Cure: monitoring or incentive?
Catch: what is the weakness of the cure?
For objective tests, match the keyword: share options → share price and risk; profit bonus → short-termism; covenants → lenders.

Common mistakes in Agency Problem and Stakeholder Conflicts

Swapping principal and agent.
The terms sound similar and students rush.
Fix: Shareholders are principals. Managers are agents. The agent acts for the principal.
Listing remuneration schemes without saying how they help.
Students memorise names only.
Fix: Link each scheme to a performance measure and to the shareholders' aim, then give a weakness.
Claiming share options solve the problem completely.
They look like a perfect link to share price.
Fix: Note that price may move for reasons outside management's control, and options can encourage risk taking or short-term price boosting.
Ignoring other stakeholders such as lenders and employees.
The focus is only on managers against shareholders.
Fix: Name the group, its objective and the conflict, for example lenders' covenants against risky projects.
Forgetting monitoring and governance as a solution.
Students think only of pay.
Fix: Mention audit, non-executive directors, audit and remuneration committees, and disclosure.
Giving generic answers that ignore the scenario.
Students write memorised notes.
Fix: Use the numbers and facts given, such as bonus based on current-year profit, to show the specific issue.

Worked examples

Example 1

The managers of Delta Co receive a bonus based only on current-year profit. Explain the agency problem this creates and suggest two ways to improve goal congruence.

Show the solution

Managers are agents of the shareholders, who are the principals. Shareholders want long-term wealth.
A bonus on current-year profit encourages short-termism. Managers may cut research, training or maintenance to lift profit this year.
They may also use aggressive accounting to increase profit. This raises agency costs because long-term value falls.
Improvement 1: base part of the reward on share price or total shareholder return over several years, for example an LTIP.
Improvement 2: pay part of the bonus in shares that must be held for some years, and add monitoring through a remuneration committee of non-executive directors.
Weakness: share-based schemes can be affected by market movements outside management's control.

Answer: A current-year profit bonus encourages short-termism and manipulation, which reduces shareholder wealth. Multi-year share-based rewards such as LTIPs, plus oversight by a remuneration committee, improve goal congruence, though share prices are not fully controllable by managers.

Example 2

A company's share price at the start of the year was $4.00 and at the end $4.60. It paid a dividend of $0.20 per share. Directors' bonuses depend on total shareholder return (TSR). Calculate TSR and state one drawback of using it.

Show the solution

TSR = (P₁ − P₀ + D) ÷ P₀.
Capital gain = 4.60 − 4.00 = $0.60.
Add dividend: 0.60 + 0.20 = $0.80.
Divide by opening price: 0.80 ÷ 4.00 = 0.20.
TSR = 20%.
Drawback: the share price may rise because of market-wide movements, not management effort, so directors may be rewarded or penalised for factors they do not control.

Answer: TSR = 20%. A drawback is that market-wide price changes, not management performance, may drive the result.

Exam tips

Use scenario facts. Name the exact measure that drives the bonus and say what behaviour it encourages.
Always give both a benefit and a weakness of any remuneration scheme. Evaluation earns marks.
Objective tests often ask which scheme or action fits a conflict. Match short-termism to profit bonuses and risk taking to share options.
Keep principal and agent straight. Write them down before you answer.
In 20-mark questions, link agency theory back to the financial objective of shareholder wealth maximisation.

Practice questions from The nature and purpose of financial management

Agency Problem and Stakeholder Conflicts 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 Stakeholder Conflicts: frequently asked questions

What is the agency problem in ACCA FM?

It is the risk that managers, who act as agents for shareholders, pursue their own interests instead of maximising shareholder wealth. It arises from the separation of ownership and control and from information asymmetry.

What are agency costs?

They are the costs of dealing with the agency problem. They include monitoring costs, the cost of incentive schemes and the value lost when managers still make poor decisions.

How do executive share options help goal congruence?

They give managers a financial gain if the share price rises, which links their reward to shareholder wealth. However, they may encourage risk taking or short-term price manipulation, and market movements can affect the payoff.

Which stakeholder conflicts can appear in the exam?

Common ones are shareholders against lenders over risk and dividends, against employees over pay and jobs, and against the community or government over cost, tax and the environment. Explain the conflict using the scenario.