Chapter 12

MANAGEMENT COMPENSATION

Formal Control Process

Goals and strategies (Chp 2 & 13) Rules (Chp 3) Other information Reward (feedback) Strategic Planning (Chp 8) Responsibility center Performance (Chp 10 & 11) Was performance satisfactory? (Chp 11 & 12) Yes No

Budgeting (Chp 9)

Report actual vs plan

Revise

Revise

Corrective action

Measurement
Feedback Communication

Management Compensation

The incentive compensation system is a key management control device.

Research Findings on Organizational Incentives

Individuals tend to e more strongly motivated by the potential of earning rewards than by the fear of punishment. A personal reward is relative or situational. If senior management signals by its action that it regards MCS as important, operating mangers will also regards it as important. Individuals are highly motivated when they received reports, or feedback, about their performance. Motivation is weakest t=when the person believes an incentive is either unattainable or to easily attainable.

Characteristics of Incentive Compensation Plans

Compensation package:
1. 2. 3.

Salary Benefits Incentive compensation Those that relate compensation to profits currently earned by the company short term incentive plans. Those that relate performance to long-term performance long term incentive plans.

Incentive compensation plans:

1.

2.

Short-Term Incentive Plans

The Total Bonus Pool

The total amount that can be paid to a qualified group of employees in a given year. Ways to establish bonus pool:
Bonus equal to a set percentage of profit. Base bonus on the percentage of earning per share after a predetermined level of earnings per share has been attained. Base bonus on increase in profitability over the preceding year. Base bonus on their profitability relative to that of their industry.

Continued
Carryovers Deferred Compensation

Long-Term Incentive Plans

Growth in the value of the companys common stock reflects the companys long-run performance. Stock Options, the right to buy a number of shares of stock at, or after, a given date in the future (the exercise date).

Incentives for Business Unit Managers

Types of incentives:
1.

2.

Financial Rewards: Salary increases, bonuses, benefits, & prerequisite (automobiles, vacation trips, club memberships, etc) Psychological &social rewards: promotion possibilities, increased responsibilities, more autonomy, better geographical location & recognition.

Continued

Size of Bonus Relative to Salary

Fixed pay system Performance-based pay Cutoff Levels

Bonus Basis
Total corporate profit Differentiated between single firmindustry & conglomerate firms.

Performance Criteria

Financial Criteria

Profit center; investment center; cost center Removes expenses from corporate. Eliminates the effects of losses cause by acts of nature.

Adjustment for Uncontrollable factors

Benchmark for comparison.

Bonus Determination Approach

Formula-based Subjective

When managers personal control over a units performance is low.

Combination of two

Agency Theory

One party (the principal) hires another party (the agent) to perform some service &, in doing so, delegates decision making authority to the agent. Divergent Objectives of Principals & Agents.

Work aversion Risk preference

Nonobservability of Agents Actions

Information asymetry

Continued

Control Mechanism
Monitoring Incentive Contracting