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

A company's finance director manipulates quarterly results so that a bonus target tied to reported profit is met. Which governance concept best describes the underlying problem?

It is an agency problem. The finance director's bonus depends on reported profit, so he has an incentive to manipulate results to benefit himself, even though this harms shareholders who rely on accurate information. Managers' and owners' interests are misaligned.

  1. AAn agency problem arising from misaligned incentives between managers and shareholdersCorrect
  2. BA pure market risk that cannot be diversified
  3. CA liquidity shortage caused by seasonal working capital needs
  4. DA change in corporate tax rates
  5. A failure of the dividend irrelevance theory

Explanation

Managers acting in their own interest (bonus) at the expense of shareholders, who need accurate information, is the classic agency problem. Pay linked to a single reported metric creates the incentive to manipulate it. The other options do not describe a conflict of interest between managers and owners.

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