Reference no: EM132565294

Rekayasa Electronics (RE), produced a wide range of electronic equipment, including signal services, test equipment, communications systems, and various piece parts and subassemblies such as motors, generators, and probes, Total annual sales were in excess of $ 8 billion. RE stock was listed on the Bursa Efek Indonesia (BEI).

• The company's objective was to maximize shareholder value. In most of its business areas. RE 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 costs.
• The company was organized by product line. Its 16 relatively autonomous divisions were managed as profit centers. The divisions managers reported to one of four Business Group managers who, in turn, reported to the company's CEO.
• Thirty managers including all line managers as the level of division manager and above plus key corporate staff managers, were eligible for an annual management bonus award. (Many lower level employees were included in a separate "Management by - objectives "incentive plan). The management bonuses were based on companywide performance. Each year, a bonus pool equal to 10 % of the corporation's profit after taxes in excess of 12 % 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 executive eligible for a bonus. This maximum bonus paid was 150 % of salary.
• Historically RE managers had been earning bonuses that ranged from of 30% to 120% of salary, with the average approximately 50%. But because of the recession in the prior two years, the bonus pool was Zero.
• Complaints about the management bonus system had been growing, Most of them stemmed largely from 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 contribution. The quote cited at the beginning of the case was representative of these complaints.
• In response, 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 for which each manager was responsible. That is, division manager bonuses would be based 100 % on division performance, group manager bonuses would be based 100 % on group performance, and corporate manager bonuses would be based 100 % on corporate performance.

2. For bonus award purpose, actual performance would be compared with targets negotiated during RE's annual budgeting process. RE's philosophy was to try to set budget targets at

• "threshold" levels that were likely to be achieved if the management teams performed effectively. Corporate manager knew that RE was a "high tech" company that operated in many business areas in which there was significant operating uncertainty. It was often difficult to forecast the future accurately. They thought that the relatively highly achievable budget targets provided the operating managers with some insurance against an operating environment that might turn out to be harsher than that seen at the time of budget preparation.

3. Each division would be given an "economic profit" objective equal to budgeted operating profit minus budgeted operating assets multiplied by 12 %, which was assuming to be approximately RE's weighted average cost of capital. For example, a division with an operating profit budget of $ 100.000 - $ 60.000 = $ 40.000.

4. The actual investment has was calculated as follows:

Cash

Assume to be 10% of cost of sales

Receivables and Inventories

Average actual month-end balances

Fixed Assets

Average actual end-of-month net book values

5. If an entity's actual economic profits were exactly equal to its objective, the manager would earn a bonus equal to 50 % of salary. The bonus would increase linearly at a rate of five percentage points for each $ 100.000 above the objective and be reduced linearly as a rate of five percentage points for each $ 100.000 below the objective. The maximum bonus would be zero.

Questions:

Question 1. What's primary objective of profit-oriented company?

Question 2. What are the actions of Rekayasa Electronics (RE) management to be able to lead the business competition?

Question 3. Why do managers say that the current bonus system is unfair? What is the reason?

Question 4. And how is top management's response?