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

Which of the following best describes the agency problem between shareholders and managers, and a commonly used remedy as per the financial management syllabus?

The agency problem arises when managers, acting as agents, pursue their own goals instead of maximising shareholder wealth. A common remedy is aligning their interests through performance-linked compensation such as employee stock options, along with monitoring and the threat of takeover.

  1. AManagers may pursue personal goals over shareholder wealth; remedy is linking managerial compensation to performance such as employee stock optionsCorrect
  2. BCreditors may be harmed by dividend payments; remedy is increasing the dividend payout ratio
  3. CShareholders may restrict managers from borrowing; remedy is issuing only preference shares
  4. DManagers may maximise shareholder wealth at the expense of society; remedy is eliminating stock options

Explanation

The manager-shareholder agency problem arises because managers, as agents, may act in their own interest. Remedies include performance-linked pay and stock options, monitoring and the threat of takeover. The other options misstate either the parties involved or the remedy.

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