Question

China Resources Corporation (A): 6S Management CASE STUDY: Would managers behave differently if the performance contract were eliminated? Why not use the EVA-based plan to provide incentives and balanced scorecards to provide information?

Answer 1

Yes, if there is performance contract it will also encourage manager to put more efforts as there performance is measure against predefined KPI like increase in share price,increase in sales etc. At the same time it may lead to managers taking excessive risk which may lead to heavy losses to Business

EVA is measure of financial performance based on concept that all capital has cost and that earning more than the cost of capital creates value for the shareholder.It is true economic profit consisting of all cost including cost of capital. If a company return of capiatl exceeds its cost of capital it is creating true value for the shareholder.

Using EVA within a company

All managers have the same goal of obtaining capital and a earning rate of return on it that exceeds the return offered by other seekers of capital funds. EVA can be used as a financial management system that allows mangers and employees to focus on how capital is used and the cash flow generated from it. There are two benefits from focusing on growth in EVA; management’s attention is focused more towards its primary responsibility, which is increasing investors’ wealth and secondly, distortion caused by using historical cost accounting data are reduced or eliminated so that managers can spend their time finding ways to increase EVA. This increased awareness of the efficient use of capital will eventually produce additional shareholder value.

Managers can do a better job of asset management and EVA can be used to hold management accountable for all economic outlays whether they appear in the income statement, on the balance sheet or in the footnotes to the financial statements. This is possible because EVA creates one financial statement that includes all the costs of being in business, while making managers aware of every dollar they spend.

Another benefit of using EVA is that it creates a common language for making decisions, especially long-term decisions. Examples are: resolving budgeting issues and evaluating the performance of organizational units and managers. EVA quantification of results in financial terms also helps to energize other management programs such as TQM, quick response and customer development by demanding and getting continuous financial improvement.

Mangers and employees adopt a long-term focus and begin to think more like owners as they start to feel responsible for and take part in the economic value of the firm.

Benefits of EVA incentive plan

One effective way to align employees’ interest with that of investors is to tie their compensation to output from the EVA metric. People are paid for sustainable improvements in EVA. The behavior within a company is changed through the understanding of what drives EVA and economic returns.

Necessary properties for the incentive system to work:

Have an objective measure of performance that cannot be manipulated.
Plan must be simple so everyone in the organization can understand it.
Significant bonus amount to alter employees’ behavior.
Keep target fixed and do not move goalpost after plan gets under way.

Properties that are strongly recommended:

No limits should be placed on the plan.
Not paying the full bonus amount in one year in order to seek substantial performance.
Include cancellation clause whereby banked bonus is lost if a person resigns.
Incorporate long term perspective into the plan.
Structure of the plan should be team based.

Balance scorecard

A balanced scorecard is a performance metric used in strategic managment to identify and improve various internal functions of a business and their resulting external outcomes. It is used to measure and provide feedback to organizations. Data collection is crucial to providing quantitative results,as the information gathered is interpreted by managers and executives, and used to make better decision for organisation

Advantages of Balance scorecard for providing information

1. It gives structure to your strategy

2. It makes it easy to communicate your strategy.

3. It aligns your departments and divisions

4. It helps your employees see how their individual goals link to the organizational strategy

5. It keeps your strategy front and center of your reporting process.