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ACCA Strategic Professional · Advanced Financial Management · Corporate environmental, social, governance (ESG) and ethical issues

Zentra plc's chief executive holds a large share of her pay as annual cash bonuses linked to this year's reported earnings per share. She is considering cancelling a long-term R&D project that would reduce current profit but raise value over ten years. Which agency problem does this most directly illustrate?

This is managerial short-termism. A bonus tied to current-year EPS rewards cutting long-term R&D spending, even though that spending would raise shareholder value over ten years. Management's incentives are therefore misaligned with shareholders' long-term wealth, which is a classic shareholder-manager agency problem.

  1. AManagerial short-termism arising from a mismatch between management's reward horizon and shareholders' long-term wealth interestCorrect
  2. BConflict between shareholders and lenders over asset substitution
  3. CInformation asymmetry between the company and the tax authority
  4. DConflict between majority and minority shareholders over dividend policy

Explanation

Pay tied to short-term accounting earnings encourages the manager to cut value-creating long-term investment to lift the current EPS. This is a shareholder-manager agency conflict of short-termism. The lender-based option concerns debt-holder risk, which is not the issue here.

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