Linkedin Case Essay

4071 Words17 Pages
BU663: Advanced Corporate Finance
Instructor: Dr. A. Shkilko
Group 5 – Case Solution
Submitted: April 3, 2013

Braddock Industries Inc.
Long-Term Incentive Compensation System Evaluation

Darren Bahadur
Barima Peprah
Daniel Niedra
Hubery Zhao
Historical Plans
Plan 1 (1998-2002) Although Braddock was a privately held company during this time, the long-term incentive plan involved a stock-based component (case Exhibit 4) and as well as an annual performance bonus based on the matrix illustrated in case Exhibit 6.
The good * Since management compensation is tied to firm performance, managers are incentivized to keep costs under control and maintain profitability. However, it is important to balance cost-controls with
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A closer look at case Exhibit 4 shows that in 1997, Braddock management applied a performance factor of .90 to BVPS, resulting in a market price of $18.65 per share. If indeed the company had a negative outlook at that time, then this price per share could be argued. Conversely, in 2002, management applied a factor of 1.70 reflecting a positive outlook and resulting in a premium market price per share of $68.26. This ultimately provided a sizeable payout to participating managers. * A number of issues were identified in the analysis of the performance factor calculation. Management attempted to proxy the cost of equity using the bank prime lending rate plus 2%, which is a crude measure that is unlikely to reflect the true risk of the business. If the cost of equity is underestimated, the spread between ROE is inflated and the resulting market value of equity is overestimated. * With a focus on net income, managers could be incentivized to maximize ROE at the expense of other stakeholders, particularly bondholders. For instance, managers may fuel earnings growth by over-levering the company to benefit from tax shields in order to increase the value spread. In addition, there are many other ways in which managers can manipulate earnings, for example, by slowing down depreciation charges or selling off assets to realize extraordinary gains. * Using the

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