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MN20501 – Intermediate Accounting

January 2020 Exam – Suggested Solutions

Question 1 – compulsory

Section (a)

Section (b)

The achievement of stakeholder objectives by managers can be encouraged by managerial reward schemes, for example, share option schemes and performance-related pay (PRP), and by regulatory requirements, such as corporate governance codes of best practice and stock exchange listing regulations.

Share option schemes

The agency problem arises due to the separation of ownership and control, and managers pursuing their own objectives, rather than the objectives of shareholders, specifically the objective of maximising shareholder wealth. Managers can be encouraged to achieve stakeholder objectives by bringing their own objectives more in line with the objectives of stakeholders such as shareholders. This increased goal congruence can be achieved by turning the managers into shareholders through share option schemes, although the criteria by which shares are awarded need very careful consideration.

Performance-related pay

Part of the remuneration of managers can be made conditional upon their achieving specified performance targets, so that achieving these performance targets assists in achieving stakeholder objectives. Achieving a specified increase in earnings per share, for example, could be consistent with the objective of maximising shareholder wealth. Achieving a specified improvement in the quality of emissions could be consistent with a government objective of meeting international environmental targets. However, PRP performance objectives need very careful consideration if they are to be effective in encouraging managers to achieve stakeholder targets. In recent times, long-term incentive plans (LTIPs) have been accepted as more effective than PRP, especially where a company’s performance is benchmarked against that of its competitors.

Corporate governance codes of best practice

Codes of best practice have developed over time into recognised methods of encouraging managers to achieve stakeholder objectives, applying best practice to many key areas of corporate governance relating to executive remuneration, risk assessment and risk management, auditing, internal control, executive responsibility and board accountability. Codes of best practice have emphasised and supported the key role played by non-executive directors in supporting independent judgement and in following the spirit of corporate governance regulations.

Stock exchange listing regulations

These regulations seek to ensure a fair and efficient market for trading company securities such as shares and loan notes. They encourage disclosure of price-sensitive information in supporting pricing efficiency and help to decrease information asymmetry, one of the causes of the agency problem between shareholders and managers. Decreasing information asymmetry encourages managers to achieve stakeholder objectives as the quality and quantity of information available to stakeholders gives them a clearer picture of the extent to which managers are attending to their objectives.

Monitoring

One theoretical way of encouraging managers to achieve stakeholder objectives is to reduce information asymmetry by monitoring the decisions and performance of managers. One form of monitoring is auditing the financial statements of a company to confirm the quality and validity of the information provided to stakeholders.

Note: Only three ways to encourage the achievement of stakeholder objectives were required to be discussed.