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ACCA Applied Skills · Financial Management · Financial objectives and relationship with corporate strategy

A company's directors are given a bonus based solely on this year's reported earnings per share. Which problem is MOST likely to arise from this arrangement?

Directors may pursue short-term profit at the expense of long-term shareholder wealth. A bonus based only on current earnings per share encourages cutting discretionary spending or avoiding long-term projects, creating an agency conflict between managers and shareholders whose interest is sustained value.

  1. ADirectors may favour short-term profit at the expense of long-term shareholder wealthCorrect
  2. BDirectors will always maximise dividends to shareholders
  3. CDirectors will reduce borrowing to zero
  4. DDirectors will be unable to make any investment decisions

Explanation

This is an agency problem: a reward tied to short-term EPS encourages cutting discretionary spending such as R&D or delaying investment, which boosts current EPS but may harm long-term wealth. The other options are not natural consequences of the bonus design.

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