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ACCA Strategic Professional · Advanced Performance Management · Performance and reward

Zentra Ltd's shareholders (principals) employ a management team (agents) to run the business. The managers hold no shares and receive a fixed salary. Which statement best describes the core agency problem in this situation?

The agency problem is that managers may pursue their own interests rather than maximise shareholder wealth, because their goals differ and shareholders cannot fully observe managerial effort or decisions. A fixed salary with no shareholding weakens the link between manager reward and shareholder outcomes.

  1. AManagers may pursue their own interests, such as job security or perks, rather than maximising shareholder wealth, because their interests differ and shareholders cannot fully observe their effortCorrect
  2. BShareholders cannot legally remove managers who underperform
  3. CManagers always have more capital invested in the firm than shareholders
  4. DFixed salaries guarantee managers will take excessive risks to increase profit

Explanation

Agency theory rests on divergent interests and information asymmetry between principals and agents. With a fixed salary and no shareholding, managers bear little consequence from poor results and may pursue personal goals. The other options misstate the problem, and a fixed salary tends to encourage risk aversion, not excessive risk-taking.

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