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ACCA Applied Skills · Financial Management · The nature and purpose of financial management

In the context of the financial management function, which of the following best describes the agency problem between a company's shareholders and its directors?

The agency problem is the risk that directors, who act as agents for shareholders, pursue their own interests such as bonuses, status or empire building instead of maximising shareholder wealth, because ownership and control are separated in companies.

  1. ADirectors may pursue their own interests, such as bonuses or empire building, rather than maximising shareholder wealthCorrect
  2. BShareholders may prefer higher dividends while lenders prefer lower dividends, causing a conflict between the two groups
  3. CEmployees may demand higher wages than the company can afford, reducing returns to shareholders
  4. DGovernment may impose regulations that restrict the company's ability to raise new finance

Explanation

The agency problem arises because managers (agents) act for shareholders (principals) but may pursue personal goals such as higher pay or larger empires. The conflict between shareholders and lenders is a different stakeholder conflict, not the agent-principal problem between owners and managers.

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