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ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation

Which statement about the agency problem and aligning managers' behaviour with shareholder wealth maximisation is correct?

Linking part of pay to long-term total shareholder return relative to peers best aligns managers with shareholders, because it rewards dividends and share price growth over time. Annual EPS bonuses encourage short-termism, fixed salary gives no performance link, and options can promote excessive risk-taking.

  1. ABasing executive bonuses solely on annual EPS growth fully aligns managers with long-term shareholder wealth
  2. BShare options with exercise prices set below the current price eliminate the incentive for managers to take excessive risk
  3. CLinking part of remuneration to long-term total shareholder return relative to peers helps align managers' interests with shareholdersCorrect
  4. DIncreasing the proportion of fixed salary is the most effective way to align managers with shareholders

Explanation

Relative TSR over a multi-year period reflects dividends and capital gains and filters out market-wide movements, so it ties pay to shareholder wealth. EPS-only bonuses encourage short-termism and manipulation. Fixed salary gives no link to performance, and options can encourage risk-taking since managers share the upside but not the downside.

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