Skip to content

ACCA Strategic Professional · Strategic Business Leader · Agency

Dornfield Ltd's shareholders offer the finance director a share option scheme to align her interests with theirs. After its introduction, she approves several very high-risk projects with a small chance of large gains. Share price falls would cost her little, as the options simply expire worthless. What is the most accurate analysis?

The option scheme gives the finance director an asymmetric payoff: she gains from big successes but loses little if projects fail. This encourages excessive risk-taking, so the incentive itself creates agency cost and does not fully align her interests with shareholders.

  1. AThe scheme has created an asymmetric payoff that encourages excessive risk-taking, so it is itself a source of agency costCorrect
  2. BThe scheme has eliminated agency costs because her interests now match shareholders'
  3. CThe behaviour shows risk aversion, which options normally cause
  4. DThe behaviour shows that monitoring costs are zero

Explanation

Options give upside without downside, unlike shares, so the agent may take excessive risk. This means the incentive device can generate its own agency cost rather than removing it. Risk aversion is the opposite of the behaviour described, and agency costs are rarely eliminated entirely.

Did you get it right without looking?

One question tells you little. A timed set on Agency shows your real accuracy, how long you take and where you lose marks.

Practise AgencyFree diagnostic mock

More Agency questions