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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

Zenith plc has 20 million shares in issue at $5.00 each. Its CEO owns 2% of the shares. A value-destroying overseas acquisition will cost shareholders $8 million in total value but will give the CEO personal benefits worth $0.5 million. What is the CEO's net personal gain or loss from the acquisition, assuming the CEO bears a proportionate share of the value loss?

The CEO gains a net $0.34 million. The CEO bears 2% of the $8 million value loss, which is $0.16 million, against personal benefits of $0.5 million. Because the personal gain exceeds the share of the loss, the CEO is motivated to proceed, illustrating an agency problem.

  1. ANet gain of $0.34 millionCorrect
  2. BNet gain of $0.50 million
  3. CNet loss of $0.16 million
  4. DNet loss of $7.50 million

Explanation

The CEO's share of the value loss is 2% x $8m = $0.16m. The net result is the benefit of $0.5m less $0.16m = a gain of $0.34m. Ignoring the CEO's own loss gives $0.5m, and deducting the full $8m gives $7.5m loss; both are wrong. The CEO therefore has an incentive to proceed despite the destruction of value.

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