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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Delmar Corp's chief executive is rewarded on annual accounting profit. She proposes cutting research and training spending, which will lift this year's profit but is expected to lower long-term cash flows. Which statement best describes the issue for shareholder value?

This is short-termism arising from an agency conflict. Annual profit rewards cutting research and training even though long-term cash flows fall, so rewards linked to multi-year value measures such as EVA or total shareholder return would better align management with shareholder wealth.

  1. AShort-termism: the reward measure conflicts with long-term value, so measures based on future cash flows or EVA over several years would align interests betterCorrect
  2. BGoal congruence is achieved because profit and shareholder value always move together
  3. CIt is an agency issue only if the company pays no dividends
  4. DIt is an issue of stakeholder power, which a higher profit target would resolve

Explanation

Rewarding annual profit encourages cutting discretionary spend that creates future value, an agency conflict between manager and shareholders. Linking rewards to longer-term value measures such as multi-year EVA or shareholder return reduces this. Profit and value do not always move together.

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