Essay Berkshire Case

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Question 1: Were the Berkshire’s motivations for a new incentive system reasonable? If so, what were their main options for a new system? Was an economic-focused system a reasonable choice? The use of accounting-based incentive system where EPS was a measure of performance had caused two concerns: 1. Agency problem: manager’s interests were not aligned with those of shareowners. While EPS had been improving steadily at the rate of 9% annually, share price had increased only slightly. 2. The use of subjectivity in granting bonus awards: * Makes bonus awards loosely correlated with the realized operating performance: mangers were given bonus even in years when their entity did not perform well * Engages manager in…show more content…
* | Still focuses on the past, while economic income reflects changes in future cash flow potentials => still likely to be a poor indicator of value changes for company. Be affected by controllability problemsEx: the economic profit system was not applied to Spirits Division as it was not responsive to changing market conditions. Create understandability problems. measures can be complex and are not as widely familiar.Ex: a number of managers in Berkshire seemed not to understand how the economic profit measure was computed.Expensiverequire assistance from consultants , management development and training time. | More training courses for managersCombine with non-financial measures. | 2. The Automatic ratcheting of performance target * In the first year the performance targets were set based on a projection of the unit’s historical economic profit growth rate. If the growth rate was deemed to be good performance, multiplied by 75% * Thereafter performance targets were set automatically based on improvements from the actual performance of the prior year. * Each business unit’s performance target was ratcheted up (down) by 75% of the amount by which actual performance exceeded (fell short of ) the unit’s prior year’s performance Pros |

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