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ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation

Zeta plc's board pays its executives mainly through annual cash bonuses linked to reported earnings per share (EPS). Which conflict between managers and shareholders is MOST likely to be encouraged by this scheme?

An EPS-linked annual bonus encourages managers to pursue short-term earnings growth, possibly cutting investment or rejecting long-term positive NPV projects, which harms long-term shareholder wealth. This is a classic agency conflict arising from a short-term, accounting-based performance measure.

  1. AManagers favour short-term earnings growth, even at the expense of long-term shareholder wealthCorrect
  2. BManagers favour paying out all earnings as dividends to maximise share price
  3. CManagers reduce gearing to zero to increase shareholder risk
  4. DManagers accept only projects with positive NPV regardless of EPS effects

Explanation

Bonuses tied to EPS reward short-term accounting profit. Managers may cut R&D or reject long-term positive NPV projects that depress current EPS. Paying out all earnings or avoiding gearing is not specifically encouraged by an EPS bonus, and accepting all positive NPV projects is what shareholders want.

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