Braddock Industries Inc. Harvard Case Solution & Analysis

BRADDOCK INDUSTRIES, INC

1.      What factors in a company’s operating performance drive shareholder value? How important is revenue growth? How important is earnings/share growth?

SHAREHOLDER VALUE

      Shareholder Value is a broad term which encompasses many concepts. Normally, shareholder value is used to refer to creation of the shareholder wealth within an organization. Apart from this, there are many other meanings of this word such as it also refers to the market capitalization of the company, the increase in the share price of the company and also the excess rate of return earned from the company’s cost of capital. The main drivers of shareholder value in a company are many such as: the revenue growth rate, dividend growth rate, the economic value added created on the company’s cost of capital and also the cash value added. If the company invests in such projects and makes such decisions that coincide with the interests of the shareholders, then shareholder wealth is generated.

REVENUE GROWTH

      Revenue growth is the growth in the sales revenue, either decrease or increase, over a set period of time. This is expressed as a percentage rate which can be stated for quarters, six monthly or annual revenue growth rates. This shows how much the business is expanding. It is one of the important metrics for measuring the future projections of sales for the company. If the revenue growth rate of a company increases over a period of time, this would have a positive impact on the cash flows of the company, provided the working capital management of the company is strong. This would increase the value of shareholders.

EARNING PER SHARE GROWTH

      This is one of the measures of the firm’s profitability. It is the amount of the profit allocated to the ordinary shareholders of the company. The earning per share, however, is based upon the historical earnings. Two companies might have the same earning per share number, but one company might need higher capital to achieve that earning per share. However, if we express this earning per share in terms of growth as a percentage it gives us meaningful results. The earning per share growth rate tells us about the company’s future prospects. However, EPS is a measure that does not take account of cost of equity of a firm and therefore, it does not reflect an appropriate cost of capital. Therefore, if the company increases their borrowing, they can increase EPS. That is the reason for which this is not an important measure of shareholder value creation.

2.Carefully examine each of the incentive plans presented in Exhibits 4, 5, 6 and 8. From the perspective of management what do you like/dislike about each plan? How successful is each plan in aligning management and shareholder interests? Why do you think each plan was ultimately replaced?

LONG TERM INCENTIVE PLAN (1ST PLAN)

      The first incentive plan was introduced for a period of five years. This plan was specifically based on the book values and the increases in the book value of the shares. Also the performance factor was based on the book value of the shares. Apart from this the performance factor was also based on the difference between the company’s return on equity with the banks’ prime interest rate. This ignores the cost of equity of the company and there is no logical reasoning for taking these to rates together. Therefore, this incentive plan seems poor from both the management and the shareholder’s perspective because there is no connection between book values and shareholders wealth. This is the reason that this plan was replaced after the first 5 years.

LONG TERM INCENTIVE PLAN (2ND PLAN)

      The second long term incentive plan was introduced in the year 2003. Cash payments were given to the shareholders of the company based on the cumulative operating income of the prior 3 years. The drawback with this incentive plan was that the company was actually paying its shareholders cash payments based on non-cash items being included in the operating income. The earnings before interest and taxes includes depreciation and amortization, therefore, the management has room to perform creative accounting practices by manipulating the depreciation and amortization expenses by changing the accounting estimates. Therefore, managers might like this approach but it does not increase shareholders value in any way.

ANNUAL INCENTIVE (BONUS) PLAN

            The annual incentive bonus plan was based on the increases in the revenue growth rates and the profitability of the company measured by return on assets. Though, both of these measures have no direct connection with shareholder creation but still, they were indirectly related. The bonus targets were stated as a percentage in the form of a matrix and the managers were motivated to increase the growth rate of revenue and also increase the profitability of the company................................

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This is considered the driving force of economic value creation for shareholders, and these drivers are reflected in the various incentives compensation management software. The case is also regarded as financial results of business units can be assessed using measures of economic value creation. "Hide
by William E. Fruhan Source: Harvard Business School 17 pages. Publication Date: February 14, 2011. Prod. #: 211061-PDF-ENG

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