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Chapter 12

Paramita Sari
Rachma Dilla Fauzan
Roberto Fernando Siahaan
Chapter 12
Management Compensation

i Research Findings on Organizational Incentives

ii Characteristics of Incentive Compensation Plans

iii Incentive for Corporate Officers

iv Incentive for Business Unit Managers

v Agency Theory

vI Case Study
Research Findings on
Organizational Incentives
• Individual tend to be more strongly motivated by rewards than
• Personal reward is relative or situational
• Senior management action to management control system will
influence the operating manager action toward it
• Individuals are highly motivated when they receive reports or
feedback of their performance
• Incentive become less effective as the period between an
action and feedback on it increases
• Motivation is weakest when the person believes an incentive is
either unattainable or too easily attainable
Compensation Package


Salary Compensation

Characteristics of
Incentive Compensation Plans
• Short-Term Incentive Plans
• Long Term Incentive Plans
Short-Term Incentive Plans

The Total Bonus • The total amount of bonus that can be paid to a
Pool qualified group of employees in a given year

• An annual carryover of part of the amount

Carryovers determined by the bonus formula

Deferred • Bonus payment to recipients may be spread out

Compensation over a period of years.
Long Term Incentive Plans

Stock Options

Phantom Shares

Stock Appreciation Shares

Performance Shares

Performance Units
Stock Options

A right to buy a number of shares of stock at, or after, a given

date in the future (the exercise date), at a price agreed upon
at the time option is granted (usually the current market price
or 95 percent of the current market price)

Phantom Shares
Award managers a number of shares for bookkeeping
purposes only. At the end of a specified period (for example
five years) the executive is entitled to receive an award equal
to the appreciation in the market value of the stock since the
date of award.
Stock Appreciation Rights
A right to receive cash payments based on the increase in the
stock’s value from the time of the award until a specified
future date.

Performance Shares
Award specified number of shares of stock to a manager when
specific long-term goals have been met.

Performance Units
A cash bonus is paid when specific long-term targets are
Incentives for Corporate Officers
CEO Compensation
- Discussed by the board of
directors compensation
committee after the CEO has
presented recommendation
for subordinates’
Incentive for Business Unit Managers

Types of Incentives

Psychological and
Financial Rewards
Social Rewards

Salary increase Promotion possibilities

Increased responsibilities
Increased autonomy
Better geographical location

Perquisites Recognition
Size of Bonus Relatives to Salary
Incentive for Business Unit Managers

Upper Cutoffs
Size of
Relative to Lower Cutoffs

Business Unit Profits

Bonus Company Profits

Based on
Incentive for Business Unit Managers
Performance Criteria
Financial Nonfinancial Assigned To Benchmark for
Time Period
Criteria Criteria Financial And Comparison
Contribution margin Sales growth
Profit budget
Direct business unit Annual financial Market share
profit performance
Controllable Customer
business unit profit satisfaction
Income before
Quality Past performance
New product
Net income
Return on Multiyear financial Personnel
Investment performance development Competitor’s
Economic value
Public responsibility
Incentive for Business Unit Managers

Determination Subjective

Form of Stock Options
Payment Phantom Shares
Performance Shares
Combination of the Two
Agency Theory
The Concepts
• Divergent Objectives of Principals and Agents
• Nonobservability of Agent’s Actions

Control Mechanisms
• Monitoring
• Incentive Contracting

CEO Compensation and Stock Ownership Plans

Business Unit Managers and Accounting-Based Incentives
Case Study

Worthington Industries
Company’s Background

• Founded in 1955 by John H.McConnell, essentially invented

the steel processing industry.
• Headquartered in Columbus, Ohio, operated 53 plants in 11
countries and boasted 7500 employees.
• John P.McConnell became chairman and CEO in 1996.
• In 1999, company’s sales revenue was $1.8 billion in steel
processing and metals-related businesses.
• 1998-1999 selected as one of the “100 Best Places to Work” by
Fortune Magazine.
Company’s Value

The Golden Rule :

“We treat our customers, employees,

investors, and suppliers, as we would
like to be treated”
Organization Structrure
Human Resources Policies
• Had Employee Councils.
• Employees councils’s member : Production
• Employee councils’s responsibilities : decide
whether new employees should become
• Relationship between councils and managers were
cordial. Working as a team.
• Workers had plenty of opportunity to move up the
career ladder at Worthington.
Reward Systems
Rewarded for good performance through
competitive salaries and profit sharing plans.
Case Question
Evaluate the management systems at Washington
Industries from the stand-point of how they help
the company to outperform its competitors.
Case Analysis