ACCA Strategic Professional · Strategic Business Leader · Agency
Brightwater Ltd rewards its managing director with a bonus based solely on this year's reported profit. Shareholders observe that she has cut research spending and delayed maintenance, lifting profit this year while weakening long-term prospects. Which change to the remuneration design would best address this agency problem?
Adding long-term share-based awards that vest over several years and depend on sustained shareholder return best addresses the problem. It links the director's reward to long-term value, removing the incentive to boost current profit by cutting research and maintenance.
- AIncrease the cash bonus percentage on annual profit
- BAdd long-term share-based awards vesting over several years, linked to sustained shareholder returnCorrect
- CReplace the bonus with a higher fixed salary
- DRequire monthly profit reports to the board
Explanation
The problem is short-termism caused by a narrow, short-period incentive. Long-term awards aligning the agent's wealth with sustained shareholder value address this directly. A larger annual bonus worsens it, a fixed salary removes alignment, and more reporting only monitors without correcting the incentive.
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