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CA Intermediate · Financial Management and Strategic Management · Scope and Objectives of Financial Management

Under the agency relationship between shareholders and managers, which of the following is an example of an agency cost incurred by shareholders to keep managers aligned with their interests?

Granting managers employee stock options linked to share price is an agency cost, because it is an incentive that shareholders bear to align managers' interests with wealth maximisation. The other choices do not address the manager-shareholder conflict or are not agency costs at all.

  1. AGranting managers employee stock options linked to share price performanceCorrect
  2. BDeclaring a higher dividend to creditors
  3. CPaying a statutory audit fee to the tax department
  4. DMaintaining a higher cash balance for operations

Explanation

Agency costs include incentive costs such as stock options or performance-linked pay, plus monitoring and bonding costs, designed to align managers with shareholder wealth. The other options are not mechanisms to reduce the manager-shareholder conflict; dividends are not paid to creditors and cash balance is a liquidity matter.

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