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ACCA Strategic Professional · Advanced Performance Management · Performance and reward

Corvane Group pays its divisional managers a bonus of 5% of divisional profit above a budget the managers themselves help set. Managers consistently submit budgets with easy targets and then spend heavily at year end to use up unspent budget. Which combination of agency problems is shown, and which redesign best addresses both?

The behaviour shows budgetary slack driven by information asymmetry, plus year-end spending to protect next year's budget. The best response is to set targets using central benchmarks or relative performance, use rolling forecasts, and base rewards on longer-term outcomes, so managers gain nothing from understating potential or wasting budget.

  1. AOnly adverse selection; replace managers
  2. BBudgetary slack and information asymmetry, plus a spend-it-or-lose-it behaviour; use stretching, centrally benchmarked or relative targets with rolling forecasts, and reward on long-term outcomesCorrect
  3. COnly risk aversion; increase fixed salary to remove the bonus
  4. DOnly moral hazard from audit weakness; add more external auditors

Explanation

Managers hold private information about achievable performance and use participation in budgeting to build slack, while year-end spending reflects incentive to protect future budgets. Fixing this needs targets less dependent on the agent's own submissions, such as benchmarking, relative performance and rolling forecasts, and rewards linked to longer-term outcomes. Raising fixed pay or adding audit does not remove the slack incentive.

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