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ACCA Applied Knowledge · Business and Technology · Governance in business organisations

The directors of Kestrel Co, a listed company, have rejected a profitable but risky project because failure could cost them their jobs, even though shareholders would benefit from the expected return. Which agency problem does this best illustrate?

The best fit is managers being more risk averse than diversified shareholders. Directors depend on one company for their income and careers, so they reject risky positive-return projects, whereas shareholders spread risk across portfolios and would accept the project for its expected return.

  1. AManagers being more risk averse than shareholders, who hold diversified portfoliosCorrect
  2. BManagers taking excessive perquisites at shareholders' expense
  3. CManagers manipulating reported profit to increase their bonuses
  4. DShareholders being unable to attend general meetings

Explanation

Managers' careers depend on one company, so they avoid risk, while diversified shareholders accept it for higher returns. This is a divergence in risk attitude. Perquisites and profit manipulation involve different behaviours not described here.

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