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IAI Actuarial Core Principles · Business Finance · Corporate governance and the regulation of companies

A board links 50% of a director's long-term bonus to growth in earnings per share (EPS) alone. Which risk is most directly created by this single metric?

The main risk is that directors manipulate or inflate EPS through buybacks, underinvestment or extra gearing, actions that lift the metric without creating genuine shareholder value. A single accounting-based measure can be gamed, so boards usually combine it with other measures such as return on capital or total shareholder return.

  1. ADirectors may boost EPS through buybacks or cost cuts that do not create real valueCorrect
  2. BDirectors will be unable to receive any dividends
  3. CShareholders will lose their voting rights
  4. DThe company will be unable to appoint non-executive directors
  5. The company's accounts will no longer need auditing

Explanation

EPS can be raised by reducing share count through buybacks, cutting investment or using more debt, none of which necessarily adds value. The other options are unrelated consequences of a remuneration metric.

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