MANAGEMENT

COMPENSATION
Management Control Systems
Chapter 12

September 2014

Iwan Pudjanegara, SE., MM.

Research Findings on
Organizational Incentives
People are influenced by both positive and
negative incentives.
A Positive Incentive = REWARD, is an
outcome that increases satisfaction of
individual needs.
A Negative Incentive = PUNISHMENT, is
an outcome that decreases satisfaction of
individual needs.
September 2014

Iwan Pudjanegara, SE., MM.

Research Findings on
Organizational Incentives
Research on incentives tends to support :
1) Individuals tend to be more strongly
motivated by the potential of earning
rewards than by the fear of punishment
(MCS should be reward oriented).
2) A personal reward is relative or
situational. Monetery compensation is an
important means of satisfying needs.
September 2014

Iwan Pudjanegara, SE., MM.

Research Findings on
Organizational Incentives
3) If senior management signals by its
actions that it regards the MCS as
important, operating managers will
also regard it as important.
4) Individuals are highly motivated
when they receive reports, or
feedback about their performance.
September 2014

Iwan Pudjanegara, SE., MM.

Research Findings on
Organizational Incentives
5) Incentives become less effective as the
period between an action and feedback
on it increases.
6) Motivation is weakest when the person
believes an incentive is either
unatainable or too easily attainable.
Motivation is strong when it takes some
effort to attain the objective.
September 2014

Iwan Pudjanegara, SE., MM.

Research Findings on
Organizational Incentives
7) The incentive that a budget or other
statement of objective provides is
strongest when managers work with
their superiors to arrive at the
budgeted amounts. Objectives, goals,
or standards are likely to provide strong
incentives only if the manager
perceives them as fair.
September 2014

Iwan Pudjanegara, SE., MM.

Characteristics of
Incentives Compensation Plans
A managers total compensation package
consists of 3 components :
1. Salary
2. Benefits
3. Incentive compensation
The 3 components are interdependent, but
the incentive compensation is related
specifically to MC function.
September 2014

Iwan Pudjanegara, SE., MM.

Characteristics of
Incentives Compensation Plans

Managers typically receive higher

compensation in large companies than
in small firms, and companies in the same
industry tend to compete with each other
on compensation.
Incentive compensation plans must be
approved by the BOD and the
shareholders.
September 2014

Iwan Pudjanegara, SE., MM.

Characteristics of
Incentives Compensation Plans
2 types of Incentive Compensation Plans:
1) Short-term Incentive Plans
2) Long-term Incentive Plans
Short-term incentives plans are based on
performance in the current year.
Long-term incentives plans are based on
longer-term accomplishment and are
related to the price of companys CS.
September 2014

Iwan Pudjanegara, SE., MM.

Short-Term Incentive Plans

The Total Bonus Pool
Carryovers
Deferred Compensation

September 2014

Iwan Pudjanegara, SE., MM.

10

Short-Term Incentive Plans

(The Total Bonus Pool)
Total Bonus Pool : the total amount
of bonus that can be paid to a
qualified group of employees in a
given year.
This formula usually is related to the
overall company profitability in the
current year.
September 2014

Iwan Pudjanegara, SE., MM.

11

Short-Term Incentive Plans

(The Total Bonus Pool)
Several methods to establish The
Bonus Pool :
The bonus equal to a set percentage
of the profits.
Many companies dont like using this
method because it means paying a bonus
even when profitability is low.
September 2014

Iwan Pudjanegara, SE., MM.

12

Short-Term Incentive Plans

(The Total Bonus Pool)
Pay bonuses only after a specified
return has been earned on capital.
To base the bonus on a percentage of
earnings per share after a predetermined
level of earnings per share has been attained.
However, this method does not take into
account in investment from reinvested
earnings.
September 2014

Iwan Pudjanegara, SE., MM.

13

Short-Term Incentive Plans

(The Total Bonus Pool)
The bonus is equal to a percent of the profits
before taxes and interest on long-term debt,
minus a capital charge on the total of
shareholder equity plus long-term debt.
The reason why companies using this
method because managerial performance
should be based on employing corporate
net assets profitably & financial policy.

September 2014

Iwan Pudjanegara, SE., MM.

14

Short-Term Incentive Plans

(The Total Bonus Pool)
To define capital as equal to shareholder
equity.
A difficulty with both this and the
preceding methods is that a loss year
reduces shareholder equtiy and thereby
increases the amount of bonus to be paid
in profitable years.

September 2014

Iwan Pudjanegara, SE., MM.

15

Short-Term Incentive Plans

(The Total Bonus Pool)
Base the bonus on increases in
profitability over the preceding year.
Base bonuses on their profitability
relative to that of their industry.

September 2014

Iwan Pudjanegara, SE., MM.

16

Short-Term Incentive Plans

(Carryovers)
An annual carryover of a part of the amount
determined by the bonus formula.
Advantages :
It is more flexible
It can reduce the magnitude of the swings
that occur when the bonus payment is
based strictly on formula amount
calculated each yr.
September 2014

Iwan Pudjanegara, SE., MM.

17

Long-Term Incentive Plans

Stock Options
Phantom Shares
Stock Appreciation Rights
Performance Shares
Performance Units
(find out their definition!!! Page 518-520)
September 2014

Iwan Pudjanegara, SE., MM.

18

Incentives for BU Managers

(Types of Incentives)
1. Financial Rewards
a)
b)
c)
d)

Salary Increase
Bonuses
Benefits
Perquisites (automobiles, vacation
trips, club memberships, etc.)

September 2014

Iwan Pudjanegara, SE., MM.

19

Incentives for BU Managers

(Types of Incentives)
2. Psychological & Social Rewards
a)
b)
c)
d)
e)

Promotion Possibilities
Increased Responsibilities
Increased Autonomy
Better Geographical Location
Recognition (=pengakuan,
penghargaan)

September 2014

Iwan Pudjanegara, SE., MM.

20

Incentives for BU Managers

(Size of Bonus & Based on)
Size of Bonus Relative to Salary
1) Upper Cutoffs
2) Lower Cutoffs

Bonus Based on
1) Business Unit Profits
2) Company Profits
3) Combination of the Two
September 2014

Iwan Pudjanegara, SE., MM.

21

Incentives for BU Managers

(Performance Criteria)
1. Financial Criteria
a)
b)
c)
d)
e)
f)
g)

Contribution Margin
Direct BU Profit
Controllable BU Profit
Income Before Taxes (IBT)
Net Income (NI)
Return on Investment (ROI)
Economic Value Added (EVA)

September 2014

Iwan Pudjanegara, SE., MM.

22

Incentives for BU Managers

(Performance Criteria)
2. Time Period
a) Annual Financial Performance
b) Multiyear Financial Performance
3. Nonfinancial Criteria
a) Sales Growth
b) Market Share
c) Customer Satisfaction
d) Quality
September 2014

Iwan Pudjanegara, SE., MM.

23

Incentives for BU Managers

(Performance Criteria)
e) New Product Development
f) Personnel Development
g) Public Responsibility

4. Relative Weights Assigned to Financial &

Nonfinancial Criteria
5. Benchmarks for Comparison
a) Profit Budget b) Past Performance
c) Competitors Performance
September 2014

Iwan Pudjanegara, SE., MM.

24

Incentives for BU Managers

(Bonus Determination & Form)
Bonus Determination Approach
1) Formula-Based
2) Subjective
3) Combination of the Two

Form of Bonus Payment

1) Cash
2) Stock
3) Stock Options 4) Phantom Shares
5) Performance Shares
September 2014

Iwan Pudjanegara, SE., MM.

25

Agency Theory
Concepts
Divergent Objectives of Principals and Agents
Nonobservability of AgentsActions

Control Mechanisms
Monitoring
Incentive Contracting
CEO Compensation and SOP
BU Managers & Accounting-Based Incentive
September 2014

Iwan Pudjanegara, SE., MM.

26

Case 12-2 Crown Point Cabinetry

Team Presentation!!!

September 2014

Iwan Pudjanegara, SE., MM.

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