Founded in 1852, Berkshire Industries PLC grew from a brewery serving local pubs to a medium-sized publicly held corporation focused on the beverages and snack foods industry. The brewery used a decentralized strategy in terms of the structure of its operations, focusing on four divisions; beer, spirits, soft drinks and snack foods. Up until 2000, the company’s annual planning process related to the incentive systems was a bottom-up process where each operating divisions proposing their earning targets and how they will achieve them. Each division was united under a common goal: maximize shareholders’ value. Berkshire’s Objectives of its Incentive Plan
Ever since Berkshire went public, it instituted an incentive plan for division and lowel-level managers. The system was built to achieve three objectives; to ensure the congruence between management and shareholders’ interest, to provide additional motivation for managers to work harder and to provide a simple and objective performance evaluation. In comparison, division and lowel-level managers’ objectives are maximizing their annual revenue and having the necessary power and understanding to influence their yearly compensation. It is senior management’s responsibility to make sure there are sufficient incentives for the managers to behave in the company best interest and maximize shareholder value. Unfortunately, this was not the case under both the old and new incentive plan. The Desired Characteristics of an Incentive Plan
An incentive must fulfill several important criteria to be considered effective; it should be valued, understandable, timely, durable, reversible, cost-efficient and congruent. However, on the case of Berkshire, the employees and management explicitly prioritized some of the criteria. Berkshire is a 150 year-old company. With its established brand, it is reasonable to assume that management must have a definite long-term plan for the company. Management prioritizes the durability and the reversibility of the incentive plan. Also, because of the current recession, it must ensure that the incentive plan is cost-effective for the company. Finally, it was explicitly expressed by the board that they valued an accurate, simple and objective performance measurement that “goes up when shareowner value is created and goes down when value is destroyed” It was explicitly expressed by the managers that they want to understand how their compensation was determined in order for them to have maximum control over their division. Also, a significant and timely compensation will ensure their full cooperation in aligning the firm with their own objective. It is crucial that the incentive plan can provide for both the needs of the Board and managers in order for the incentive plan to work properly. ISSUES
Issue I – Old Incentive Plan Based on EPS
The lack of shareholder value creation at Berkshire can be traced back to their old incentive plan based on EPS. The main issue regarding EPS as a performance measure was its lack of congruency towards the company’s objective of maximizing shareholder value. EPS is not a very comprehensive performance measure as it neglects a division’s cost of capital and investment, leading to a minimal effect on the company’s share price. The lack of shareholder value creation was noticed by senior management as “EPS had been improving steadily (9% annual) over the last decade but the share price had increased slightly during that time frame”.
Secondly, the EPS incentive plan was very subjective as the plan was influenced by an annual incentive compensation group of forty members, all of which were senior managers at Berkshire. This lack of objectivity allowed managers at Berkshire to significantly impact the compensation committee headed by members of the Board of Directors. The lack of independence was further noticed as division managers were able to set their own goals with...