case study

1. UNIVERSITY OF NEGROS OCCIDENTAL – RECOLETOS
RECOLETOS DE BACOLOD GRADUATE SCHOOL
BACOLOD CITY
DOCTOR OF PHILOSOPHY IN BUSINESS MANAGEMENT
Prepared by: Mark Stephen Pere-ira, MBA
Submitted to: KRISTINE ANN J. POLANA, CPA, PhD
INDUSTRIAL ELECTRONICS, INC.
INTRODUCTION
Industrial Electronics, Inc. (IE) produced a wide range of electronic equipment,
including signal sources, test equipment, communication systems, and various piece parts
and sub-assemblies such as motors, generators, and probes. Total annual sales were in
excess of $8 billion.
The Company’s objective was to maximize shareholder value. In most of its
business areas. IE had to be innovative to stay ahead of the competition. However, price
competition was also significant, so the company also had to maintain tight control over
cost.
The company was organized by product line. Its 16 relatively autonomous
divisions were managed as profit centers. The division managers reported to one of four
Business Group managers who, in turn, reported to the company’s CEO.
Twenty-five managers, including all managers at the level of division manager
and above, were eligible for an annual management bonus award.
The Management bonuses were based on company-wide performance. Each year,
a bonus pool equal to 10 percent of the corporation’s profit after taxes in excess of 12
percent of the company’s book net worth was set aside for assignment as bonuses to
managers. This amount was divided by the total salary of all the executives eligible for a
bonus. This yielded an “award per dollar of salary”. The maximum bonus paid was 150
percent of salary.
Historically Industrial Electronics managers had been earning bonuses that
ranging from of 30% - 120% of salary, with the average approximately 50%. But because
of the recession, in the years 2000 and 2001, the bonus pool was zero.
Complaints about the management bonus system had been growing. Most of
them stemmed largely division managers whose divisions were performing well, even
while the corporation as a whole was not performing well. These managers believed that
the current bonus system was unfair because it failed to properly recognize their
contributions.
In response, top management, with the assistance of personnel in the corporate
Human Resource and Finance departments, proposed a new management bonus plan.
The current bonus system also only allows for bonuses to be distributed if there are
profits more than 10% (after taxes) in excess of 12% of the company's net book worth. If
profits are low, then no bonuses are distributed. This was the case in years 2000 and 2001
when IE was adversely affected by the economy recession – there was no money in the

2. bonus pool at all.
The amount calculated above was then divided by all the executives that were
eligible for a bonus in that given year. Another problem within this system is that all
managers eligible are equally distributed the total amount set aside for a bonus. This
means that a manager that sets records for sales and efficiency is awarded the same bonus
amount as a manager that barely surpasses performance goals. This does not seem fair.
A good thing is that there is the potential to earn more than 100% of salary as a bonus.
Most employees would consider this a very healthy bonus, even though the average sits
around 50% of salary.
POINT OF VIEW:
Industrial Electronics, Inc. Division Manager, General Products Division.
OBJECTIVE:
Specifically, the objective of the study is to evaluate the current and proposed
bonus system and to develop a new bonus plan system.
PROBLEM:
What bonus system is optimal for Industrial Electronics, Inc. the current or the
proposal?
Areas of Consideration
In response to the complaints, top management with the assistance of personnel in the
corporate Human Resources and Finance departments, proposed a new management
bonus plan with the following features:
1. Bonuses would be determined by the performance of the entity of which each
manager was responsible. That is, division manager bonuses would be based 100
percent on division performance; group manager bonuses would be based 100
percent on group performance; and corporate manager bonuses would be based
100 percent on corporate performance.
2. For bonus award purposes, actual performance would be compared with targets
negotiated during IE’s annual budgeting process. IE’s philosophy was to try to set
budget targets so that they were 80-90 percent achievable by effectively
performing management teams. Corporate managers knew that IE was a “high
tech” company that operated in many business areas in which it was difficult to
forecast the future accurately.
3. Each division would be given an “economic profit” objective equal to budgeted
operating profit minus budgeted operating asset multiplied by 12 percent, which
was assumed to be approximately IE’s weighted average cost of capital.
4. The actual investment base was calculated as follows:

3. Cash Assumed to be 10 percent of cost of sales
Receivables & Inventories Average Actual month-end balances
Fixed Assets Average actual end-of-month net book values
5. If the entity’s actual economic profits were exactly equal to its objective, the
manager would earn a bonus equal 50 percent of salary. The bonus would
increase linearly at a rate of the five percentage points for each $100,000 above
the objective and be reduced linearly by five percentage points for each $100,000
below the objective. The maximum bonus would be 150 percent of salary. The
minimum bonus would be zero.
($000)
Division Budgeted
Operating
Profit
Budgeted
Operating
Assets
Actual
Operating
Profit
Actual
Operating
Assets
A $1,000 $8,000 $1,150 $7,000
B 1,000 8,000 4,500 7,000
C 50 1,000 300 800
D (700) 4,000 (300) 4,200
E 600 2,000 100 1,800
C. TOWS (Threats/Opportunities/Weaknesses/Strength)
Threats:
1. Economic recession
2. The timeless goal (12%) does not reflect the economic situation or changes in
the situation.
3. The bonus cut offs, both at the bottom (corporate performance below 12%)
and the top (maximum bonus of 150% of salary).
Opportunities:
1. Can create a new system on bonus plan.
Weaknesses:
1. Division manager’s bonus awards are little affected if their division has an
outstanding or a poor year.
2. No charge for the use of assets that are financed by debt. The asset and the
debt net to zero in the effect on book net worth.
Strengths:
1. There is a wealth sharing system.
2. The system is easily understandable
3. The system might encourage team work because everyone is rewarded on the
same measure of performance.
Alternative Courses Action
1. Use the current (old) bonus system which is based on a share of overall corporate
profit after taxes in excess of 12% of book net worth.
Advantages Disadvantages
1. It is a wealth sharing system. If the 1. Division manager’s bonus awards are little

4. company does well, all managers do
well and vice versa. The company has
to make larger payouts when it is best
able to do so.
2. The system might encourage team
work because everyone is rewarded on
the same measure of performance.
3. The performance targets are fixed and
timeless. Thus there are no politics in
the negotiation of performance targets.
4. The system is easily understandable
affected if their division has an outstanding
or a poor year.
2. The timeless goal (12%) does not reflect the
economic situation or changes in the
situation.
3. Profit after tax is not a good reflection of
value creation.
4. There is no charge for the use of assets that
are financed by debt. The asset and the debt
net to zero in the effect on book net worth.
5. The bonus cut offs, both at the bottom
(corporate performance below 12%) and the
top (maximum bonus of 150% of salary) are
potentially bad.
2. Use of proposed new management bonus plan. The bonus awards (as percent of
base salary) in Division a to E is as follows:
DIVISION
A B C D E
A. Budgeted Operating Profit 1,000 1,000 59 (700) 600
B. Budgeted Operating Assets 8,000 8,000 1,000 4,000 2,000
C. Actual Operating Profits 1,150 4,500 300 (300) 100
D. Actual Operating Assets 7,000 7,000 800 4,200 1,800
E. Objective Economic Profit 40 40 (61) (1,180) 360
F. Actual Economic Profit 310 3,660 204 (804) (116)
G. Difference (E-F) 270 3,620 265 376 (476)
H. Rate of Increase 13.5% 181% 13.25% 18.8% (23.8)
BONUS RATE of salary 63.5% 150% 63.25% 68.8% 26.20%
The new proposed management bonus plan has the following advantages and
disadvantages:
Advantages Disadvantages
1. The measures are more
controllable. Division managers
will be held accountable for
division results; group managers
for group managers; and
corporate managers for corporate
results.
2. The awards are based on an
economic profit, or residual
income, performance measure.
1. The performance measure, which are
accounting-based are short-term oriented.
This could be particularly costly in a high
technology business where innovation is a
critical success factor.
2. The measures are just uniform, summary
results indicators. They are not at all linked
with strategy, and they provoke no operating
guidance for managers as to how to
accomplish the result.

5. Mangers would be charged for
tying up assets in their business.
3. The type of financing used to
acquire the assets would not
affect the measure.
4. The performance targets, would
be tailored to each business unit.
Presumably they would be more
realistic and more equitable and
would engender greater
commitment from each of the
managers.
3. Charging for fixed assets based on net book
values will cause problem: NBV-related
measures motivate managers not to replace
older, more depreciated assets.
4. The costs of capital does not vary across
operating units and it seems not to change
over time.
5. Budget targets are difficult to set equitably in
uncertain environment such as IE.
6. The system provides room for gamesmanship
(e.g. window dressing)
7. There is scalability problem that may be
perceived by some managers to be
unfair.($100,000 economic profit is different
across division).
Recommendation
Based on the result of the current bonus system and the new proposed
management bonus plan, it is highly recommended to develop a new annual Employee
Bonus Plan. The plan should covers from all management position. The bonus
computation should consider the individual performance and the company performance
of each division or department. This would be more equitable and motivating on the part
of the managers. Additionally, this can give opportunity each division to be more creative
in implementing strategies in meeting the targets.