ACCA Strategic Professional · Strategic Business Leader · Agency
Orlin Group's board proposes to cut agency costs by tying 80% of the CEO's pay to annual share price growth. A non-executive director warns this may backfire. Which concern is the most valid application of agency theory's limits?
The valid concern is that heavily share-price-linked pay can encourage short-term behaviour, excessive risk-taking or manipulation of reported results. The incentive meant to align manager and shareholder interests may therefore create fresh conflicts and harm long-term value, a recognised limit of agency-based remedies.
- AShare-based pay removes all information asymmetry between managers and shareholders
- BShort-term share price targets may encourage risk-taking or manipulation of results, creating new conflicts with long-term shareholder and stakeholder interestsCorrect
- CPay linked to performance is prohibited under all governance codes
- DThe CEO becomes a principal and the shareholders become agents
Explanation
Incentives aimed at aligning interests can induce short-termism, excessive risk or earnings manipulation, so the fix may create a new agency problem. Information asymmetry is not eliminated by pay design, and codes encourage, not prohibit, performance-related pay.
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