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ACCA Strategic Professional · Advanced Financial Management · Strategic business and financial planning for multinational organisations

Zeta plc's chief executive receives a bonus based solely on this year's earnings per share. She proposes cutting research spending by 40% to lift EPS, although this would reduce the present value of future cash flows. Which governance problem does this best illustrate?

This is an agency conflict. The executive's bonus depends on short-term EPS, so she is motivated to cut research spending even though that lowers long-term value for shareholders. Linking rewards to long-term value measures would better align her interests with shareholders.

  1. AAgency conflict arising from a short-term performance measure that is not aligned with long-term shareholder wealthCorrect
  2. BInformation asymmetry caused by foreign exchange translation differences
  3. CA pure financial risk arising from excessive gearing
  4. DPositive signalling of a progressive dividend policy

Explanation

The manager's reward is tied to short-term EPS, which encourages actions that raise EPS but cut long-term value. This is an agency problem of misaligned incentives. Aligning pay with long-term measures such as shareholder return, economic profit or share-based awards with vesting periods would reduce it.

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