1. MANAGEMENT COMPENSATION
Management Control Systems
Chapter 12
September 2014
Iwan Pudjanegara, SE., MM.

2. 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.

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

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

5. Research Findings on Organizational Incentives
Incentives 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 unatainable or too easily attainable. Motivation is strong when it takes some effort to attain the objective.
September 2014
Iwan Pudjanegara, SE., MM.

6. Research Findings on Organizational Incentives
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.

7. Characteristics of Incentives Compensation Plans
A manager’s total compensation package consists of 3 components :
Salary
Benefits
Incentive compensation
The 3 components are interdependent, but “the incentive compensation” is related specifically to MC function.
September 2014
Iwan Pudjanegara, SE., MM.

8. 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.

9. Characteristics of Incentives Compensation Plans
2 types of Incentive Compensation Plans:
Short-term Incentive Plans
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 company’s CS.
September 2014
Iwan Pudjanegara, SE., MM.

10. Short-Term Incentive Plans
The Total Bonus Pool
Carryovers
Deferred Compensation
September 2014
Iwan Pudjanegara, SE., MM.

11. 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.

12. 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 don’t like using this method because it means paying a bonus even when profitability is low.
September 2014
Iwan Pudjanegara, SE., MM.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. Long-Term Incentive Plans
Stock Options
Phantom Shares
Stock Appreciation Rights
Performance Shares
Performance Units
(find out their definition!!! Page )
September 2014
Iwan Pudjanegara, SE., MM.

19. Incentives for BU Managers (Types of Incentives)
Financial Rewards
Salary Increase
Bonuses
Benefits
Perquisites (automobiles, vacation trips, club memberships, etc.)
September 2014
Iwan Pudjanegara, SE., MM.

20. Incentives for BU Managers (Types of Incentives)
Psychological & Social Rewards
Promotion Possibilities
Increased Responsibilities
Increased Autonomy
Better Geographical Location
Recognition (=pengakuan, penghargaan)
September 2014
Iwan Pudjanegara, SE., MM.

21. Incentives for BU Managers (Size of Bonus & Based on)
Size of Bonus Relative to Salary
Upper Cutoffs
Lower Cutoffs
Bonus Based on
Business Unit Profits
Company Profits
Combination of the Two
September 2014
Iwan Pudjanegara, SE., MM.

22. Incentives for BU Managers (Performance Criteria)
Financial Criteria
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.

23. Incentives for BU Managers (Performance Criteria)
Time Period
Annual Financial Performance
Multiyear Financial Performance
Nonfinancial Criteria
Sales Growth
Market Share
Customer Satisfaction
Quality
September 2014
Iwan Pudjanegara, SE., MM.

24. Incentives for BU Managers (Performance Criteria)
New Product Development
Personnel Development
Public Responsibility
Relative Weights Assigned to Financial & Nonfinancial Criteria
Benchmarks for Comparison
Profit Budget b) Past Performance
Competitor’s Performance
September 2014
Iwan Pudjanegara, SE., MM.

25. Incentives for BU Managers (Bonus Determination & Form)
Bonus Determination Approach
Formula-Based
Subjective
Combination of the Two
Form of Bonus Payment
Cash ) Stock
Stock Options 4) Phantom Shares
Performance Shares
September 2014
Iwan Pudjanegara, SE., MM.

26. Agency Theory Concepts Control Mechanisms
Divergent Objectives of Principals and Agents
Nonobservability of Agents’Actions
Control Mechanisms
Monitoring
Incentive Contracting
CEO Compensation and SOP
BU Managers & Accounting-Based Incentive
September 2014
Iwan Pudjanegara, SE., MM.