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Financial Management EnvironmentFinancial management functionAgency TheoryCorporate Governance

ACCA · Question 1 · Financial Management Environment

Section A

NexusDAO is a decentralized autonomous organization transitioning into a formalized corporate structure to attract institutional investors. The founders are concerned about the classic 'agency problem' arising once external shareholders provide capital.

Which of the following mechanisms is MOST likely to align the interests of the new external shareholders with the executive directors of NexusDAO?

Answer options:

A.

Increasing the proportion of fixed salary in the directors' remuneration packages.

B.

Linking executive remuneration to long-term total shareholder return (TSR).

C.

Appointing executive directors to the remuneration committee.

D.

Setting performance targets based solely on short-term earnings per share (EPS).

How to approach this question

Recall the definition of the agency problem (separation of ownership and control) and identify which option directly ties management's personal wealth to the long-term wealth of the shareholders.

Full Answer

B.Linking executive remuneration to long-term total shareholder return (TSR).✓ Correct
The agency problem occurs when managers (agents) do not act in the best interests of the shareholders (principals). Goal congruence is best achieved by linking executive pay to metrics that reflect shareholder wealth creation, such as Total Shareholder Return (TSR), over a long-term horizon.

Common mistakes

Selecting EPS (Option D) is a common mistake; however, EPS can be manipulated in the short term and does not necessarily reflect long-term cash flow or risk.
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