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ACCA Strategic Professional · Strategic Business Leader · Agency

Kestrel Foods grants its directors share options exercisable in three years at today's market price of $5. Following a market-wide rise, the share price is $8 although Kestrel's performance was below that of its peers. Which criticism of this scheme is most valid from an agency perspective?

The strongest criticism is that the options reward general market rises rather than the directors' own contribution, so pay is not linked to relative performance or effort. Kestrel underperformed its peers yet the directors still gain, which weakens the incentive alignment the scheme was meant to create.

  1. AOptions always make directors more risk-averse than shareholders
  2. BOptions cannot be used to link pay to share price
  3. CThe scheme rewards general market movements rather than the directors' own performance, so it weakens the link between pay and effortCorrect
  4. DOptions eliminate the need for any monitoring by the board

Explanation

Options at a fixed exercise price gain value in a rising market regardless of relative performance, so directors are rewarded for luck. Options normally encourage risk-taking rather than risk-aversion, and they link pay to share price. They do not remove the need for monitoring.

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