ACCA Strategic Professional · Advanced Financial Management · Corporate environmental, social, governance (ESG) and ethical issues
A multinational's chief executive receives a bonus based solely on annual earnings per share. Shareholders suspect she is delaying a long-term, positive-NPV investment in renewable plant because it would depress current-year earnings. Which agency problem does this behaviour best illustrate?
The behaviour shows managerial short-termism, an agency conflict. Pay tied to annual EPS leads the executive to delay a positive-NPV project that would cut current earnings, so her incentives diverge from shareholders' interest in long-term wealth maximisation.
- AManagerial short-termism arising from a misalignment between remuneration metrics and shareholder wealth maximisationCorrect
- BMoral hazard arising from the company's gearing level being too high
- CAdverse selection arising from hidden information about the company's products
- DDividend clientele effect arising from changes in the payout ratio
Explanation
Basing pay on short-term EPS encourages managers to reject projects that raise long-term value but reduce current earnings. This is a classic agency conflict between managers and shareholders. Gearing-related moral hazard concerns shareholder-versus-lender conflict, which is not described here.
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