Question 7

Why might the managers' interest differ

from those of shareholders? What can
shareholders do to ensure that they do not
suffer financially because managers'
interest differ from their own?
Managers have always been known to lead and direct an
organization or a company by deploying and manipulating of
resources i.e. the human, capital, natural, intellectual and
intangible.
Shareholders on the other hand are the one who holds one or
more shares of stock in a joint-stock company.
The shareholders want to see higher profits as more dividends
can be yield from it.
Managers are more interested in higher revenue because it means
more expenses can be made that are beneficial to them.
The shareholders may want to invest in many companies so that
they are holding less risk if one company might go into
liquidation and so the shareholders financial security are not
threatened.
The manager's financial security on the other hand relies on what
happen to companies that employ them which therefore
consequent them to not favor the shareholders of investing the
companies' fund in risky investment.
 Question 13

Although managers have incentives t

o transfer wealth from shareholders t
o themselves from lenders to sharehol
ders, there are various factors that ca
n limit the wealth transfers. What are
those factors, and how do they work
to constrain the wealth transfer?
 From lenders to shareholders

If firms have debt contracts in place with conv

enants that limit the amount that firms can
borrow to, say, a certain propotion of total
tangible assets, managers acting on behalf
of shareholders have incentives to use inco
me and asset increasing accounting measur
es to ensure that they do not technically voi
late the debt convenant, even though the fi
rm's financial situation is poor.
In this way, the interest rate and other factors are no
t renegotiated, the lenders end up taking on more risk
than expected, and the effect is to transfer wealth fro
m the lenders to shareholders
 Question 16

Bonus plans are used to reduce the agency

cost of equity. Describe the agency
relationship giving rise to the agency cost
of equity and explain how bonus plans can
reduce particular types of agency problems
The separation of ownership and control means that
managers can act in their own interest, which may be
contrary to the interest of shareholders. This can be broken
down into a number of specific difficulties:

 Risk aversion problem. Managers prefer less risk than shareholders

because their human capital is tied to the firm. They prefer to diversify
their own risk rather than maximizing the value of the firm through
higher risk projects.
 Dividend retention problem. Mangers prefer to pay out less of the firm’s
earnings in dividends in order to pay for their own perquisites.
 Horizon problem. Mangers are only interested in cash flows affecting
their remuneration for the period they remain with the firm, whereas
shareholders have a long term interest in the firm’s cash flows because
share prices equal the present value of shareholders expectation of all
future cash flow
Bonus schemes can reduce these problems by tying the
managers remuneration to an index of the firm’s performance
that has a high correlation with the value of the firm (for
example, share prices, earnings). This aligns managers and
shareholders interest by tying managerial compensation to
performance ex ante without the need to rely on ex post
mechanism, such as renegotiating salary.

Remuneration can also be tied to dividend payout ratios or to

options or share bonus schemes. It is likely that a bonus plan
will reward managers only after they have achieved an
“expected” level of firm profits for a period-then the
remuneration will increase as profitability increases, thereby
providing incentives for managers to increase their bonus by
increasing firm profitability.
There may also be a ceiling on the amount of bonus paid to
managers, to reflect the fact that profits can sometimes be
increased to artificially high levels by action that are not in
the shareholders long term interest (for example by reducing
repairs and maintenance, not undertaking research and
development
 Question 20

In context of positive accounting theory, p

olitical costs can reduce the value of firms
significantly,
a) Give examples of how firms can be exp
osed to political costs,
b) Give examples of how a firm's exposure
to political costs can influence the nature
and/or content of the firm's annual report,
particularly in relation to its accounting inf
a) If a firms records high profits this might be u
sed as an excuse for trade unions or lobby gro
ups to take action for an increase in a share of
that profit ie higher wages. Therefore firms ma
y adop income-decreasing accounting method

b) Political cost theory therefore can also expla

in why many firms adopt voluntary social and
environmental disclosure in there annual repo
rts.
 CASE STUDY

Question 1:
How does this article and the underlying
profit increase demostrate signalling
theory? In your answer, explain what, if
anything, is costly to replicate and therefore
gives the signal credibility.
Accounting reports are often used to signal
information about a firm. It can demonstrate signaling
theory if it is by voluntarily disclosing bad news
reducing and increasing dividends, smoothing earnings
impairing assets and recognizing internally generated
assets.

It is costly to replicate and gives the signal credibility

as the cost can include the long term loss of credibility
if actual performance does not match the level that has
been signaled via the way in which profitability has
been represented in the account.
 CASE STUDY

Question 2:
Apply the theories described in this chapter
to explain the increase in reported earnings
from the following perspectives:
a) ex post opportunism
b) ex ante contractual efficiency
c) information perspective
a)In contractual terms, ex post opportunism argues that
agents have incentive to transfer wealth from principle.
This approaches argues that the debt contract implies
that managers will act in a manner that attempt to
transfer wealth from leaders to shareholders
b) In the agency theory perspective ex ante contractual
efficiency argues that agents recognize that if they
attempt to transfer wealth from principle, they will be
penalized for that activity. In the future, this line of
argument recognize that reputation effects will reduce
the remuneration paid to agents in the future if they
undertake dysfunctional behavior.
 CASE STUDY

Question 3:
Which of the approaches described in
answer to question (2) do you believes
is most applicable to this case?Why?
In my opinion, I would suggest ex post opportunism is
most applicable approach of this case. This is because
ex post opportunism which provide accounting
policies choices to avoid breaching covenants.
Chep Europe booked a 7 percent improvement in
sales. In the hope he received higher pallet prices with
further price hikes planned later this calendar year.
Unfortunately, analysts were pleased with the result,
despite its falling short of expectations.
 CASE STUDY

Question 4:
Are the approaches you described in
answer to question (2) mutually
exclusive, or can they be used to
complement each other? Explain?
It is mutually exclusive and they can be used to
compliment each other because all the approaches has
their own benefits which eventually increase the
performance of the company and it also help to
provide a better profit so that the firm can continuously
operate.