ACCA Strategic Professional · Strategic Business Leader · Agency
Brightwater Ltd's chief executive is paid a bonus based solely on this year's reported profit. Shareholders are concerned she is cutting research and maintenance spending to boost the bonus, harming long-term value. Which change to the incentive scheme best addresses this agency problem?
Granting shares that vest after several years, linked to total shareholder return, is correct. It ties the executive's reward to long-term value, discouraging cuts to research and maintenance made just to lift current profit. Larger cash bonuses or short-term revenue targets keep the short-term incentive.
- APaying the bonus as a larger cash sum at the year end
- BBasing part of the reward on shares that vest after a multi-year period linked to total shareholder returnCorrect
- CBasing the bonus on revenue growth in the current year only
- DReplacing the bonus with a fixed salary increase
Explanation
The problem is short-termism. Deferred shares vesting over several years against shareholder return tie the executive's wealth to long-term value. A larger cash bonus or revenue-only target still rewards short-term action. A fixed pay rise removes performance linkage altogether, so it does not align interests.
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