Question 11.SE.4: Virgo plc is considering introducing a system of EVA^® and w...
Virgo plc is considering introducing a system of EVA® and wants its managers to focus on the longer term rather than simply focus on the year-to-year EVA® results. The business is seeking your advice on how a management bonus system could be arranged so as to ensure that the longer term is taken into account. The business is also unclear as to how much of the managers’ pay should be paid in the form of a bonus and when such bonuses should be paid. Finally, the business is unclear as to where the balance between individual performance and corporate performance should be struck within any bonus system.
The finance director has recently produced figures that show that if Virgo plc had used EVA® over the past three years, the results would have been as follows:
| £m | |
| 2014 | 25 |
| 2015 | (20) |
| 2016 | 10 |
Required:
Set out your recommendations for a suitable bonus system for the divisional managers of the business.
Virgo plc
There is no single correct answer to this problem. The suggestions set out below are based on experiences that some businesses have had in implementing a management bonus system based on EVA® performance.
In order to get the divisional managers to think and act like the owners of the business, it is recommended that divisional performance, as measured by EVA®, should form a significant part of their total rewards. Thus, around 50 per cent of the total rewards paid to managers could be related to the EVA® that has been generated for a period. (In the case of very senior managers it could be more, and for junior managers it could be less.)
The target for managers to achieve could be a particular level of improvement in EVA® for their division over a year. A target bonus can then be set for achievement of the target level of improvement. If this target level of improvement is achieved, 100 per cent of the bonus should be paid. If the target is not achieved, an agreed percentage (below 100 per cent) could be paid according to the amount of shortfall. If, however, the target is exceeded, an agreed percentage (with no upper limits) may be paid.
The timing of the payment of management bonuses is important. In the question it was mentioned that Virgo plc wishes to encourage a longer-term view among its managers. One approach is to use a ‘bonus bank’ system whereby the bonus for a period is placed in a bank and a certain proportion (usually one-third) can be drawn in the period in which it is earned. If the target for the following period is not met, there can be a charge against the bonus bank and so the total amount available for withdrawal is reduced. This will ensure that the managers try to maintain improvements in EVA® consistently over the years.
In some cases, the amount of bonus is determined by three factors: the performance of the business as a whole (as measured by EVA®), the performance of the division (as measured by EVA®) and the performance of the particular manager (using agreed indicators of performance). Performance for the business as a whole is often given the highest weighting and individual performance the lowest weighting. Thus, 50 per cent of the bonus may be for corporate performance, 30 per cent for divisional performance and 20 per cent for individual performance.