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Dear Sir,
When reviewing the suggested answer from ACCA for part (a), I do not understand following narrative explanation:
“In fact, it may be construed that managers are only taking this action for their own benefit, as they may be closely tied to the company and therefore be exposed to total risk (both unsystematic and systematic risks). This may then become a source of agency related conflict between the management and the shareholders.”
To be more specifically, I do not understand:
1. What benefit managers may receive if they perform diversification for Chikepe.
2. Why the managers may be closely tied to the company and therefore expose both unsystematic and systematic risks?Thanks a lot.
The institutional shareholders will already be well-diversified and will not therefore benefit from this company diversifying (in fact they will be deliberately investing in this pharmaceutical company to form part of their diversified portfolios).
However the managers depend on the company for their salaries etc. and so if the company did diversify into other businesses they they would be at lower risk if this one company on its own were to have problems (because acquiring other companies would diversify and lessen the risk).
The ‘closely tied’ is referring to the fact that their employment depends on the company. The benefit to them of acquiring other companies would be that it would lessen the unsystematic risk.
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