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IAI Actuarial Core Principles · Business Finance · Ethical responsibilities of owners and managers

The managers of a firm are paid a bonus based solely on this year's reported profit. Which ethical risk does this structure most directly create?

The main risk is that managers cut long-term spending or manipulate accounting to raise this year's profit. A bonus tied to short-term reported profit gives them a personal incentive that conflicts with the long-term interests of the shareholders they serve.

  1. AManagers may cut long-term investment or manipulate accounting to lift short-term profitCorrect
  2. BManagers will refuse to take any risk at all
  3. CShareholders will lose their voting rights
  4. DThe auditors will become unnecessary
  5. The company will be unable to pay dividends

Explanation

Pay linked to one year's profit rewards short-termism. Managers may defer R&D or maintenance, or use aggressive accounting choices, which harms the long-term interests of owners. The other options do not follow from such a bonus scheme.

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