Financial objectives and stakeholders - Stakeholder objectiv...

Learning Outcomes

After reading this article, you will be able to identify major stakeholder groups, explain their financial objectives, and analyse common conflicts between them. You will understand the agency problem between shareholders and managers, and how agency issues can impact financial decision-making and corporate governance.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the influence of stakeholders and agency issues on financial objectives and decision-making. Focus your revision on:

• The identification of key stakeholder groups and their financial and other objectives
• Potential conflicts between stakeholder objectives and their effects on corporate decisions
• The agency relationship between shareholders and managers
• The role of management in balancing stakeholder interests
• Methods for aligning managers’ and shareholders’ objectives, including governance codes and reward schemes

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.

1. Which of the following is an example of a conflict between shareholders and employees?
   1. Employees want higher pay; shareholders want increased returns.
   2. Both want higher dividends.
   3. Employees want long-term investment; shareholders want higher sales.
   4. Both prefer lower costs.
2. What is the agency problem in financial management?
   1. The conflict between a firm and its customers.
   2. The conflict between managers (agents) and shareholders (principals).
   3. The disagreement between suppliers and regulators.
   4. The difference in the pay-off to lenders and shareholders.

3. Name two ways to reduce agency issues within a company.

4. True or false? All stakeholders have the same objectives when it comes to a company’s financial decisions.

Introduction

Most businesses have multiple groups with a stake in their success. These stakeholders often have diverging goals. Understanding how their objectives conflict—and how managers can deal with these conflicts—is essential for effective financial management and achieving corporate targets. One especially important conflict arises between shareholders, who own the company, and managers, who control day-to-day decisions. This leads to what is known as the agency problem.

Stakeholder Objectives

A stakeholder is any group or individual affected by, or able to affect, the operations and decisions of a business. Each has its own priorities, which can lead to competing objectives.

Key Term: stakeholder
Any party with an interest in the activities of a business, such as shareholders, managers, employees, lenders, suppliers, customers, government, and the wider community.

The main stakeholder groups relevant to a firm's financial objectives are:

• Shareholders (owners): Generally seek maximisation of their wealth, usually measured by increases in share price and dividends.
• Managers/directors: Aim to achieve corporate goals, but may pursue their own interests, such as job security, prestige, and personal rewards.
• Employees: Favour higher pay, better working conditions, and job security.
• Lenders/creditors: Want prompt interest and principal payments; prefer low financial risk.
• Customers: Seek value, fair prices, quality, and service reliability.
• Suppliers: Desire timely payments and continued business.
• Government and regulators: Focus on tax receipts, compliance, employment levels, and ethical behaviour.
• Community and environment: Interested in corporate social responsibility, minimal negative externalities, and sustainability.

These objectives often pull the business in different directions.

Key Term: stakeholder objectives
The financial or non-financial aims that different stakeholder groups wish to achieve through the company's actions and policies.

Stakeholder Conflicts

When stakeholders pursue different objectives, conflict is inevitable. Managers must balance these interests to ensure long-term corporate stability.

Common examples include:

• Employees vs. Shareholders: Employees prefer higher pay and benefits, potentially reducing profits and returns available to shareholders.
• Shareholders vs. Lenders: Shareholders may accept riskier projects for higher returns; lenders prefer stability and lower risk.
• Customers vs. Community: Customers might want low prices, but achieving these may require outsourcing or practices that harm local communities.
• Government vs. Company: Regulations may require higher spending on safety or environmental protection, reducing profits.

Worked Example 1.1

A company’s management is considering implementing automation that would increase efficiency but lead to job losses. Employees oppose it to protect jobs. Shareholders support it to increase profits and dividends.

Answer:
There is clear conflict: employees want job security; shareholders want increased profitability. Management must weigh the long-term benefits for shareholders against immediate disruption for employees.

Agency Issues

One of the most critical practical problems in corporate finance is the agency issue—the conflict of interest between managers (agents) and shareholders (principals).

Key Term: agency problem
The potential conflict where managers (agents), who control the company’s resources, may act in their own interests rather than in the best interests of the shareholders (principals) who own the business.

Key Term: principal-agent relationship
An arrangement where one party (the principal) appoints another (the agent) to perform a task or make decisions on their behalf.

The agency problem arises because:

• Shareholders delegate day-to-day decisions to managers.
• Managers may have different risk preferences and time horizons than shareholders.
• Managers might focus on short-term profits, perks, or job security.

Common agency problems include:

• Empire building (pursuing growth for its own sake)
• Excessive executive compensation
• Creative accounting to boost short-term results
• Resistance to takeovers that might benefit shareholders but threaten management jobs

Worked Example 1.2

A listed company’s managers award themselves large bonuses after a poor year, even as shareholder dividends are cut. Is this an agency problem?

Answer:
Yes, management is prioritising its own rewards over the interests of shareholders, who are experiencing reduced returns.

Reducing Agency Problems

To align management actions with shareholder interests, companies use several mechanisms:

• Remuneration schemes (e.g., bonuses, share options) that link pay to share price or long-term performance
• Regulatory requirements such as corporate governance codes that specify board structure, independent non-executive directors, and transparency
• Performance monitoring by shareholders and external auditors

Key Term: corporate governance
The system by which companies are directed and controlled, aiming to protect shareholder interests and ensure responsible management.

Key Term: managerial reward schemes
Incentive arrangements, including share options and performance-based pay, designed to encourage managers to act in line with shareholder goals.

These methods do not fully remove agency risk, but they create incentives and oversight that reduce its impact.

Worked Example 1.3

A company introduces a share option scheme for its managers, allowing them to buy shares at a fixed price in five years. How might this help solve the agency problem?

Answer:
If the share price increases, managers benefit directly, motivating them to work towards the same goal as shareholders—maximising share value.

Exam Warning

The ACCA exam may present scenarios where managers’ actions seem beneficial in the short term but hurt long-term shareholder value. Always consider whether management’s incentives are aligned with shareholder interests.

Summary

Managers must balance the objectives of multiple stakeholder groups, often facing conflicts. Particular attention must be given to the agency problem, where management may not act in shareholders’ best interests. Effective governance structures, suitable incentive schemes, and regulatory oversight can align management decisions more closely with shareholder and stakeholder goals.

Key Point Checklist

This article has covered the following key knowledge points:

• Define and identify key stakeholders and their objectives in a business
• Explain how and why stakeholder objectives may conflict
• Describe the agency problem and its implications for financial decisions
• Discuss typical agency issues, including examples from real business practice
• Outline mechanisms to align managerial behaviour with shareholder objectives, such as corporate governance and reward schemes

Key Terms and Concepts

• stakeholder
• stakeholder objectives
• agency problem
• principal-agent relationship
• corporate governance
• managerial reward schemes