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ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation

A multinational pays its chief executive a bonus based solely on growth in reported earnings per share over a one-year period. Which problem is most directly associated with this arrangement from a shareholder wealth perspective?

The main problem is short-termism. A one-year EPS bonus may lead managers to cut investment or reject long-term positive-NPV projects to boost profit, damaging long-term share value. EPS is an accounting figure ignoring risk and cash timing, so it does not align managers with shareholder wealth.

  1. AIt encourages short-termism, such as cutting investment in positive-NPV projects, which may reduce long-term share valueCorrect
  2. BIt forces the company to pay out all earnings as dividends
  3. CIt makes the company ignore reported accounting profit entirely
  4. DIt aligns managers perfectly with shareholders because EPS equals shareholder wealth

Explanation

A one-year EPS target can motivate managers to cut discretionary spending or reject long-term positive-NPV projects, an agency problem. EPS is an accounting measure and does not equal shareholder wealth, so option D is wrong.

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