LONG TERM INCENTIVE PLAN (3RD PLAN)
The third incentive plan for the company was introduced in 2006. 50% of the company’s incentive was based on the stock options given to the managers and the remaining 50% cash bonus was paid to the managers based on the compound sales and operating income growth rates. The sales growth rate seems reasonable as it shows how much the company is expanding. However, managers might have room for manipulating the revenue recognition principles to overstate the sales of the company. In the same way, earning per share is also based on historical results, therefore, managers also have a room here to perform creative accounting techniques to boost profits. The management however, seems to dislike this plan because the profitability had been achieved back on the same levels as before the global financial crisis but the sales growth rates declined, which resulted in lower incentives and this de-motivated the managers.
3. Try to work through Exhibits 9 and 10 line by line to get an understanding of how the “economic value created” incentive plan works. How well do you think this plan will work in aligning management and shareholder interests? Do you have a plan like this at your own company? Would you like to see a plan like this adopted at your own company?
The fourth incentive plan was introduced to replace the third incentive plan and also the annual bonus plan. This plan was based on the concept of economic value added for the shareholders. This is also called as the economic profit of a company. This economic profit is basically the excess return generated on the cost of the investors of the company. These investors include both the debt holders and also the equity holders of the company. If the return on the capital employed by the company with the adjustments of non-cash charges is greater than the cost of capital than the company has created value for its shareholders.
This incentive plan seems reasonable. All the non-cash charges have been excluded in the calculation of net operating profit after taxes. The calculation of spread also seems reasonable. The economic value created could also be calculated by finding the excess net operating profit after taxes on the capital employed. Also the baseline level of economic value creation was self-adjusting making the goals of each division achievable. Also the base unit value concept seemed reasonable to award compensation to the managers. Apart from this the incentive sensitivity factor also accommodated the risks in this plan and made this plan worthwhile from the point of view of managers and shareholders both. This would give us true picture of how much wealth is being generated by the shareholders. Therefore, this incentive plan seems to overcome the drawbacks of all the incentive plans introduced before. I would surely recommend this type of incentive plan in my organization, as there seems to be a reasonable connection of economic value added with the increase in the shareholder wealth.
4. What should Jim Schaff do regarding the management incentive plan at Braddock?
The latest compensation plan was based on very reasonable grounds. But it seemed too complicated for the managers to understand the plan and that how would their incentives be affected by increases or decreases in the economic value created above or below the baseline economic value set. Nevertheless, this compensation plan seems so close to the maximization of the shareholders’ value. The company can keep this plan for some of the coming years. This would surely motivate the managers of the company if they are performing well. When the time arises for the company to make certain investments and capital budgeting decision than the company should replace certain factors with other factors such as the company’s cost of capital or free cash flows to make the compensation plan more reasonable and strong. Till that time Jim Schaff should continue with this incentive plan because the current long term incentive plan seems to be appropriate, as it is aligned with the strategic aims of the organization that is the creation and maximization of the shareholders wealth......................................
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