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

Zeta plc has a bonus scheme paying managers 2% of operating profit, with no cap. A project has a positive NPV of $3m over five years but reduces profit in year 1 by $1m. Managers are considering rejecting it. Which problem does this best illustrate, and what is the most suitable response?

This shows a lack of goal congruence arising from a short-term profit-based bonus, which leads managers to reject a positive-NPV project. The best response is to redesign remuneration around long-term value creation, such as EVA or deferred share-based awards, aligning manager and shareholder interests.

  1. AGoal congruence failure from short-term incentives; redesign rewards to link to long-term value such as EVA or share-based awardsCorrect
  2. BExcessive gearing; issue more equity
  3. CExchange rate transaction risk; hedge with forwards
  4. DInformation asymmetry between lenders and shareholders; add debt covenants

Explanation

Rejecting a positive-NPV project because it lowers current profit shows managers' incentives are not aligned with shareholder wealth. Remedies include long-term, value-based rewards such as EVA or deferred share awards. Gearing, FX and covenants are unrelated to this conflict.

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