Essay by EssaySwap ContributorUniversity, Master's February 2008

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Annual Incentive Plan: At Duckworth industries, the senior managers (about 40 people) were part of the annual incentive compensation plan. This compensation plan was targeted toward division mangers and considered accounting variables such as cash flows, sales, inventory turnover, account receivables, gross margins, and other special projects in determining the bonuses of these managers. One major flaw of the plan was that it did not provide any incentive for managers to maximize those variables (e.g. profitability) that were not factored into the determination of manager bonus levels. Thus, a manager might be inclined to maximize sales growth and ignore profitability, as he had no incentive to maximize profitability. Another flaw with the existing system was that because it considered several accounting variables, it allowed managers to ?cook the books? in order to achieve target margins. Additionally, the manager may provide excessive discounts in order to increase inventory turnover, while he may concomitantly increase cost of goods sold and other related expenses to reduce overall profitability.

Another flaw of the plan was its failure to consider measurable parameters of product quality. Although the plan provided incentives to increase the numbers of units being sold, it did not take into account those units that were returned due to product defects. Again, such a scenario, in which a significant portion of managers? sales volume consists of defective units, will damage the company?s credibility, market reputation, and ultimately hurt the company?s profitability.

In 1990, the Duckworth shareholders finally realized the shortcomings of the existing incentive plan and made some fundamental changes to appropriately compensate the division mangers. Although the new plan incorporated parameters such as sales growth and profitability, this plan was still not perfectly aligned with corporate goals. The new plan still allowed division mangers to modify the accounting figures such that...