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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

In the context of the role of a senior financial executive in a listed multinational, which situation is the clearest example of the agency problem between shareholders (principals) and managers (agents)?

Managers rejecting a positive-NPV project because of personal job risk, while diversified shareholders would accept it, is the clearest manager-shareholder agency problem. The agent's interests (security) conflict with the principals' interest in maximising wealth, so value is lost through excessive managerial risk aversion.

  1. AManagers decline a positive-NPV project because it would increase the personal risk to their employment, even though shareholders are well diversifiedCorrect
  2. BShareholders sell their shares because the market price has risen above their estimate of intrinsic value
  3. CLenders include restrictive covenants in a loan agreement to secure the company's assets
  4. DThe company pays tax at the statutory rate in each country in which it operates

Explanation

Agency problems arise when managers' interests diverge from shareholders' interests. Rejecting a positive-NPV project to protect personal job security, when diversified shareholders would accept the risk, is risk-averse managerial behaviour and a classic example. Covenants relate to the creditor relationship and are a response to a different conflict, not the manager-shareholder problem described.

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