Duckworth Industries - Incentive Compensation Programs Case

Team A – Week Two

Duckworth Industries – Incentive Compensation Programs Case

In the current case, Team A examines Duckworth Industries, Inc. – an industrial manufacturer – in order to evaluate its current and proposed incentive compensation programs. Analysis and recommendations follow.

Duckworth Industries, Inc., has several incentive compensation programs for different levels of employees, each designed to address different problems or productivity issues. For plant-level employees, Duckworth has an attendance bonus program to reduce tardiness. For employees up to the shift supervisory level, Duckworth has a quality incentive plan to reward those who ensure high quality in their products and services. Duckworth also has a profit-sharing plan for all employees. Profit sharing rewards employees for increasing the company's profitability.

Duckworth offers individual incentive plans for all sales and supervisory personnel to improve accuracy, turnaround time, and sales growth. The annual incentive compensation plan is reserved for senior managers, some of which also participate in a long-term program. Duckworth implemented these programs to reward managers who achieve certain performance goals, in areas such as cash flow, sales growth of proprietary products, direct labor variances, inventory turns, accounts receivable, gross margins, and special individual projects. Duckworth’s top level executives recently participated in a five-year, long-term management incentive plan: a phantom stock plan tied to the company’s growth and profitability over a period of several years.

Before considering the Economic Value-Added (EVA) compensation incentive plan proposed in the current case, Duckworth Industries used different plans for each department. Under this system, it was possible for some departments to reach bonus status more easily than others, due to variance in incentive goals.

The proposed EVA would link management pay directly to the creation of long-run economic value to the shareholders. It is possible to calculate the EVA for each business unit; thus management of each unit can be directly compensated for their success, via a compensation formula that automatically adjusts next year's baseline to reflect this ...

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Duckworth would benefit from this plan in two major ways. First, this plan is self-maintaining, given the previously mentioned performance adjustment. Additionally, this bonus structure would be uniform for all business units, thus allowing managers to transfer between departments without losing earned benefits under EVA.

Kunkel (2005) identifies several factors that contribute to a company’s decision regarding long-term incentives: maturity, growth potential, industry, and market conditions. FASB standards, though strict, will probably cause companies to look at other forms of long-term compensation, such as restricted stock and performance plans. Such programs are usually less risky than stock options.

Savage (2004) views the rising value of the equity markets of the 1990s as helping “fuel the widespread use of employee stock options.” These plans were seen as a way to align employees with investors, provide true incentive compensation, and help provide cash through the market sales of ESOs. While rising stock market values created great wealth opportunities for ESOs, they sometimes masked poor employee performance. Similarly in the 2000s, as the stock market declined, option programs failed to reward many productive employees. These issues left many companies revisiting their long-term incentive programs.

Kleiner (1992) identified the most widely used form of incentive compensation as profit sharing. More than 30 percent of US companies have profit sharing programs (including Duckworth), with 85 percent of these putting bonuses into employee retirement funds. Under a typical profit-sharing plan, employees receive an annual bonus based on corporate profits. The advantages to this type of plan are that the incentive formula is simple and easy to communicate; it is affordable because it only pays when the firm is profitable; and it unites the financial interest of owners and employees.

The proposed EVA is based on key drivers for each business unit, including net operating profit after taxes, average capital, and the cost of capital. A bonus target, a baseline EVA, a base unit value, and a bonus sensitivity factor are calculated for each business unit. This plan does not include stock options.

In contrast, the executive compensation plan of Industrial Distribution Group (IDG), a Duckworth competitor, rewards management for increasing operating income and return on investment, increasing shareholder value, promoting growth and the efficient use of resources, and achieving specific individual goals. Performance targets are set each year based on operating objectives. Participants can elect to receive cash or company shares.

Duckworth should consider adopting a plan that includes stocks as an option to link the personal interests of employees to those of shareholders. The plan calculations should be simplified and linked to existing information. The performance targets should be reevaluated each year and set to company, business unit, or individual objectives. A plan that allows management to become "owners" will maximize shareholder wealth and minimize internal conflict.

References

Industrial Distribution Group (2005). Company homepage. Retrieved 30 May

2005, from .

Kleiner, M. (1992). Incentive pay: Not just for top management. Work Study, 41,

(2), 16. Retrieved 30 May 2005, from EbscoHost database.

Kunkel, J.G. (2005). Compensation plans and the new stock option accounting

rules. The CPA Journal, 75, (1), 28. Retrieved 30 May 2005, from

EbscoHost database.

Savage, M. (2004). Employee stock options: New valuation responsibilities and

planning opportunities. Benefits Quarterly, 20, (3), 34. Retrieved 30 May

2005, from EbscoHost database.