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ACCA Strategic Professional · Strategic Business Leader · Agency

Delta Energy's board is considering ways to reduce agency costs. A director proposes a package of: (1) a non-executive-dominated audit committee, (2) executive bonuses paid partly in deferred shares subject to clawback, and (3) a requirement that the CEO hold shares equal to twice her salary. Which statement best evaluates the package?

The package combines monitoring through the audit committee with incentive alignment and bonding through deferred shares, clawback and mandatory shareholding. It should reduce agency costs, but some residual loss will remain because information asymmetry and differing interests cannot be fully removed.

  1. AIt relies only on monitoring and so cannot influence the CEO's own interests
  2. BIt relies only on incentives and so adds no oversight
  3. CIt combines monitoring with incentive alignment and bonding, though it cannot eliminate residual loss entirelyCorrect
  4. DIt removes the separation of ownership and control, so agency costs are eliminated

Explanation

The audit committee is monitoring; deferred shares with clawback and the shareholding requirement align interests and bond the agent. Combining the approaches is sound, but information asymmetry and divergent goals mean some residual loss remains. Agency costs are reduced, not eliminated, as ownership and control remain separate.

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