Learning Outcomes
After reading this article, you should be able to explain how the interests of different stakeholders affect organisational governance and performance. You will understand agency theory, the causes and consequences of agency costs, and the roles of information asymmetry and control systems in minimising conflicts between management and stakeholders. You should be able to apply these concepts to performance measurement and management scenarios in line with ACCA APM requirements.
ACCA Advanced Performance Management (APM) Syllabus
For ACCA Advanced Performance Management (APM), you are required to understand how stakeholder relationships, agency theory, and information flows affect organisational performance and control. This article supports your knowledge of:
- The influence of internal and external stakeholders on organisational objectives and performance measurement
- The principles of agency theory and identification of agency costs within businesses
- The impact of information asymmetry on decision-making and control systems
- How appropriate controls and reporting mechanisms reduce conflicts and improve performance
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the main source of agency costs in an organisation, and give one example of such a cost?
- Which of the following best describes "information asymmetry"? a) Both parties have identical information. b) One party consistently has more or better information than the other. c) Both parties have no information. d) Information is always perfectly shared.
- Name two methods organisations use to reduce agency costs caused by conflicting objectives.
- True or false? "Control systems are only needed when external stakeholders are dissatisfied with management."
- Briefly describe how management reporting can help to reduce the effects of information asymmetry.
Introduction
Stakeholders—including shareholders, managers, employees, customers, lenders, and others—have interests that shape an organisation’s direction and performance. Governance is the system by which organisations are directed and controlled. Agency costs, information asymmetry, and control systems are central issues in aligning stakeholder objectives and maintaining effective performance management.
A clear understanding of how these factors interact helps you analyse performance management scenarios for the ACCA APM exam. This article covers agency conflicts, management accountability, and the role of information and controls in supporting effective governance.
Key Term: stakeholder
An individual or group with an interest in, or who is affected by, an organisation’s activities and performance.
STAKEHOLDER INTERESTS AND BUSINESS PERFORMANCE
Organisations serve multiple stakeholders, each with distinct priorities. For example, shareholders seek returns, employees look for job security, and customers expect quality products. These differing aims can lead to competing demands on management.
Well-managed organisations identify, balance, and prioritise stakeholder interests through effective governance frameworks.
Stakeholder Conflicts and Goal Alignment
Conflicts arise when the objectives of various stakeholders do not align. For example, a shareholder’s desire for higher dividends might conflict with management's wish to retain funds for investment.
Effective governance seeks to resolve or manage these conflicts, by clarifying roles, setting clear objectives, and introducing incentives and controls that support alignment.
Key Term: governance
The system by which organisations are directed and controlled to achieve objectives in a way that is accountable to stakeholders.
AGENCY THEORY AND AGENCY COSTS
Agency theory examines the relationship between principals (such as shareholders) who delegate responsibilities, and agents (such as managers) who carry out these activities. This delegation creates potential for divergent goals.
Key Term: agency theory
A theory explaining how conflicts occur when one party (the principal) delegates decision-making to another (the agent), who may have different objectives.Key Term: agency costs
Costs incurred due to conflicts of interest between principals and agents, including monitoring, bonding costs, and loss from agents’ non-aligned actions.
Agency Costs in Practice
Agency costs typically arise from:
- Monitoring expenses (e.g., auditing, performance reviews)
- Incentive schemes (e.g., bonuses, share options) aimed at aligning interests
- Residual loss from agents pursuing their own objectives over the principal’s
Worked Example 1.1
A listed company’s shareholders want long-term growth. However, its CEO prefers to maximise annual profits to boost a personal bonus, avoiding risky long-term projects.
What agency costs might arise in this situation?
Answer:
Agency costs include the cost of rewarding short-term profit (bonus payments misaligned with long-term value), the cost of missed opportunities due to ignoring long-term growth projects, and possible expenses associated with monitoring the CEO’s decisions to ensure they do not damage shareholder value.
INFORMATION ASYMMETRY
A major reason that agency costs arise is the unequal distribution of information. Managers often have more detailed, timely, or accurate information than shareholders or other stakeholders.
Key Term: information asymmetry
A situation where one party (usually management) has superior or more timely information compared to others (such as shareholders or creditors), affecting decisions and oversight.
Effects on Decision-Making and Performance Measurement
When managers possess information that other stakeholders do not, they may act in their own interest, such as pursuing unapproved projects or hiding poor results. Performance management systems need to mitigate information asymmetry to support effective governance.
Key Term: control
The process of setting standards, monitoring actual performance, and taking action to ensure objectives are achieved.
CONTROL SYSTEMS AND REPORTING
Control systems—including budgeting, reporting, internal controls, and audits—reduce the risk of managers acting against the interest of principals and other stakeholders.
These systems should:
- Ensure accountability for decisions and actions
- Monitor actual versus expected outcomes
- Enable stakeholders to make informed assessments and decisions
Effective information and control systems support transparency, trust, and goal congruence.
Worked Example 1.2
A board receives monthly financial and operational reports from divisional managers. The reports reveal that one division regularly overspends its budget with no documented justification.
How do control systems help reduce agency problems in this example?
Answer:
The regular reporting acts as a monitoring tool, highlighting deviations and enabling the board to question managers. This monitoring pressure can deter self-interested behaviour and supports corrective action, reducing agency costs.
Exam Warning
Be prepared to identify both the presence and the limits of controls in exam scenarios. Do not assume that formal controls alone will eliminate agency conflicts; discuss how effective information flows and appropriate incentives are also needed.
ALIGNING INTERESTS AND REDUCING AGENCY COSTS
To minimise agency costs and information asymmetry, organisations use:
- Performance-linked incentives (e.g., bonus schemes, share options)
- Clear reporting lines and responsibilities
- Strong internal reporting and external audit systems
- Regular independent reviews
These mechanisms encourage managers to act in the broader interest of all stakeholders, not just themselves.
Revision Tip
When analysing case scenarios, always identify: 1) The main stakeholder groups; 2) Where information imbalances exist; 3) What controls or incentives are in place (or missing).
Summary
Stakeholder demands can cause agency issues if management objectives differ from those of owners or other groups. Information asymmetry enables opportunistic behaviour, increasing agency costs. Proper governance, effective information systems, and robust controls are essential to align interests, reduce risks of self-interested decisions, and maintain sound organisational performance.
Key Point Checklist
This article has covered the following key knowledge points:
- Identify how stakeholders influence governance and performance in organisations
- Explain agency theory and describe the sources of agency costs
- Define information asymmetry and understand its impact on decision-making
- Evaluate the role of reporting and control systems in mitigating agency problems
- Apply these concepts to scenarios for performance measurement and management
Key Terms and Concepts
- stakeholder
- governance
- agency theory
- agency costs
- information asymmetry
- control