Advanced Performance Management · Performance and reward

Short-termism, Manipulation and Ethical Issues in Reward for APM

Updated 11 October 2026 · Fact-checked

Short-termism and manipulation arise when rewards are tied to narrow, short-period measures. Managers then chase the measure, not the firm's long-term value. To answer APM questions, spot the measure, state the behaviour it encourages, explain the harm using the scenario, and recommend fixes such as balanced measures, deferral and clawback.

Understand Short-termism, Manipulation and Ethical Issues in Reward

A reward scheme tells managers what the firm values. If a bonus depends on one number in one year, managers will work to move that number. This is rational. The problem is that the number is often only a proxy for what shareholders really want, which is long-term value.

Short-termism means favouring results in the current period at the expense of the future. Typical actions are cutting R&D, training, maintenance and marketing, because these costs hit this year's profit but pay back later. Delaying investment in positive-NPV projects is another example. The manager gains the bonus. The firm loses future cash flows.

Manipulation means changing reported results without changing real performance. Examples include bringing revenue forward, delaying expenses, aggressive estimates for provisions, channel stuffing, and choosing accounting policies that flatter profit. It can also mean gaming targets: sandbagging budgets so they are easy to beat, or bunching sales to just clear a threshold. At the extreme it is fraud.

Risk-taking is a third problem. Share options pay out if the share price rises but lose nothing if it falls, so holders may favour high-risk projects. Bonuses that are capped at the bottom but unlimited at the top have the same effect. Shareholders, who bear the downside, may prefer lower risk. This is an agency problem: the agent's interests differ from the principal's.

Ethical issues go wider. Executive pay may look excessive or unrelated to performance, rewarding failure, or rising faster than pay for other staff. Managers may feel pressure to act dishonestly. Fairness, transparency and integrity are at stake, and the firm's reputation and stakeholder trust can suffer. Remedies include balanced measures, long-term vesting, deferral and clawback, independent remuneration committees, disclosure, a strong ethical culture and whistleblowing channels.

Key rules to remember

Reward-behaviour link: Measure rewarded → behaviour encouraged → effect on long-term value; Use this chain to structure every answer. Name the measure first, then the behaviour, then the harm.
Goal congruence test: Does the manager's gain from the bonus = the shareholders' gain from the action?; If not, there is an agency problem and the scheme needs redesign.
Residual income: RI = Divisional profit − (Capital employed × Cost of capital); Often suggested to reduce under-investment seen with ROI. It is still a single-year measure, so it does not remove short-termism by itself.
Fixes checklist: Balanced measures + long-term vesting + deferral + clawback + independent oversight + disclosure; Link each fix to a specific problem. Do not just list them.

How to solve Short-termism, Manipulation and Ethical Issues in Reward questions

Use this method for any question on dysfunctional reward behaviour. It covers discussion, evaluation and report-style requirements.

1Read the requirement and note the verb: identify, explain, evaluate or recommend. Note who you are writing for, such as the board or remuneration committee.
2Find the reward measure in the scenario: profit, EPS, share price, sales, ROI, a budget target or a time period.
3For each measure, state the behaviour it encourages. Use facts from the scenario, such as numbers, dates, targets and thresholds.
4Classify the problem: short-termism, manipulation or gaming, excessive risk-taking, or an ethical or fairness concern. Explain the harm to long-term value and stakeholders.
5Link to theory briefly, such as agency theory or goal congruence, only where it adds a point.
6Recommend fixes matched to each problem, for example non-financial measures, vesting over several years, clawback, or independent review. Note the limits of each fix.
7Reach a clear conclusion or recommendation. Show professional scepticism and commercial judgement, and keep the tone suited to the audience.

Quickest way: Measure, Behaviour, Harm, Fix

When to use it: Use this when time is short or for a 5 to 10 mark discussion point.

Write four short column labels on your plan: Measure, Behaviour, Harm, Fix.
Fill one row per scenario fact. Aim for 4 to 6 rows.
Write each row as one or two sentences in the same order.
Add one ethical comment if the scenario hints at pressure, dishonesty or unfair pay.
Finish with a one-line recommendation.

Common mistakes in Short-termism, Manipulation and Ethical Issues in Reward

Listing generic problems of bonuses without using the scenario.
Students memorise a list and write it out.
Fix: Quote the scenario's measure, target and time frame in each point. Professional skills marks depend on applying the facts.
Treating manipulation as the same as short-termism.
Both involve bonuses and short periods.
Fix: Short-termism changes real decisions. Manipulation changes reported numbers. Name which one you are describing.
Blaming managers only and ignoring the scheme design.
Students focus on the ethics of individuals.
Fix: Show that the scheme created the incentive. Then say what the board should change, as well as what the managers did wrong.
Recommending more financial measures as the only fix.
Students think a better ratio solves the problem.
Fix: Add non-financial measures, longer vesting, deferral and clawback. Note that any single measure can still be gamed.
Saying share options always cut short-termism.
Options align managers with the share price, so students assume they solve it.
Fix: Options can still encourage risk-taking and short-term share price boosts. Discuss vesting period, exercise conditions and the downside gap.
Ignoring ethics and stakeholder views, such as employees, regulators and the public.
Students stay within the shareholder-versus-manager frame.
Fix: Mention fairness, transparency, reputation and trust. Name the stakeholders affected.

Worked examples

Example 1

A manufacturing company pays its divisional managers an annual bonus based only on divisional operating profit. Last year a manager cut the maintenance budget by $400,000 and delayed a staff training programme costing $150,000. The division's profit rose by $550,000 and the bonus was paid. Explain the behaviour and recommend changes to the scheme.

Show the solution

Measure: annual divisional operating profit, a single-year financial figure.
Behaviour: the manager cut discretionary spending of $400,000 + $150,000 = $550,000. This equals the entire profit rise, so none of the improvement came from better operations.
Harm: lower maintenance risks breakdowns, quality problems and higher future repair costs. Delayed training lowers skills and morale. These costs fall in later periods and on the company, not the manager.
Classification: this is short-termism, a real decision driven by the bonus rather than accounting manipulation. It is also a goal congruence failure.
Fixes: add non-financial measures such as equipment downtime, quality and staff development. Defer part of the bonus over several years. Use clawback if later results show damage. Review maintenance and training budgets separately so they cannot be cut to lift profit.
Conclusion: the bonus rewarded cost cutting that destroyed value, so the scheme should balance current profit with long-term health.

Answer: The profit-only bonus encouraged the manager to cut $550,000 of maintenance and training, which equals the whole profit increase. This is short-termism that harms long-term value. The company should add non-financial measures, defer part of the bonus, use clawback and protect key budgets.

Example 2

A listed company's finance director receives a bonus only if earnings per share (EPS) reaches a target of 80 cents. Before the year end, forecast EPS is 76 cents. Profit after tax is expected to be $38 million with 50 million shares. The director proposes recognising $2.2 million of next year's sales this year (after tax effect) and releasing a provision. Evaluate the proposal and its ethical implications.

Show the solution

Check forecast EPS: $38m ÷ 50m shares = $0.76, or 76 cents. This matches the scenario.
Target EPS of 80 cents needs profit after tax of 0.80 × 50m = $40 million. The shortfall is $2 million.
Recognising $2.2m of after-tax profit from next year's sales would give $38m + $2.2m = $40.2m. EPS would be $40.2m ÷ 50m = 80.4 cents, just above the target.
This is manipulation: the profit is moved between periods without any real improvement. Revenue recognised before it is earned breaches IFRS 15 principles. The provision release, if not justified by changed circumstances, also breaches IFRS.
The proposal is also an ethical problem. It threatens integrity and objectivity, misleads investors, and may be fraud. The director has a personal interest in the result.
Consequences: next year's profit will be lower unless manipulation continues. If found, there is reputational damage, restatement, regulatory action and loss of investor trust.
Recommendation: do not accept the proposal. The audit committee and external auditor should be informed. The board should redesign the bonus to include several years, non-financial targets and clawback, and ensure the remuneration committee is independent.

Answer: The $2.2m shift would lift EPS from 76 cents to 80.4 cents, just over the 80 cent target that needs $40m of profit. This is manipulation and unethical, and likely breaches IFRS. Reject it, escalate to the audit committee, and redesign the bonus with longer horizons, broader measures and clawback.

Exam tips

Always tie each point to a number, target or time frame in the scenario. Generic answers lose professional skills marks.
Check your arithmetic when a scenario gives figures. Showing how a bonus threshold was just met is a strong point.
Use the ethical lens when the scenario mentions pressure, bonuses near thresholds or misreporting. Name the principles at risk, such as integrity and objectivity.
Give balanced fixes with their limits. Examiners reward judgement, not a list.
Write for the audience named in the requirement. A board report needs a clear recommendation and a measured, professional tone.

Practice questions from Performance and reward

Short-termism, Manipulation and Ethical Issues in Reward: frequently asked questions

What is short-termism in executive reward?

It is when pay depends on short-period results, so managers favour current profit over long-term value. They may cut R&D, training or maintenance to hit targets. The firm bears the later cost.

How do bonuses lead to earnings manipulation?

If a bonus pays out at a profit or EPS threshold, managers gain by moving revenue or costs between periods or using flattering estimates. The reported figure changes but real performance does not. Weak controls make this easier.

How can a company reduce dysfunctional behaviour from rewards?

Use a mix of financial and non-financial measures, spread vesting over several years and defer part of the pay. Add clawback and independent remuneration oversight. Disclose pay policy clearly. No single fix is complete.

Do share options solve the agency problem?

Not fully. They link pay to share price, but holders gain from rises and lose nothing from falls, so they may take excess risk or boost the price short term. Design features such as vesting periods and performance conditions matter.