CFA Level I · CFA Level I Exam · Investors and Other Stakeholders
A company has substantial free cash flow and few positive-NPV projects. Management proposes to retain the cash for new, low-return ventures. Which action would most likely reduce the resulting agency conflict between shareholders and management?
Committing to share repurchases or dividends is most likely to reduce the conflict. Paying out excess cash limits management's discretion to invest in low-return projects, aligning managers with shareholders, whereas higher fixed pay or more debt-funded projects does not.
- AIncreasing the manager's fixed salary
- BCommitting to share repurchases or dividendsCorrect
- CIssuing additional debt to finance the ventures
Explanation
Returning excess cash removes management's discretion to waste it on poor projects, limiting free cash flow agency costs. A higher fixed salary does not align interests. Using more debt to fund low-return ventures worsens risk and does not address the incentive problem.
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