BU663: Advanced Corporate Finance
Instructor: Dr. A. Shkilko
Group 5 – Case Solution
Submitted: April 3, 2013
Braddock Industries Inc.
Long-Term Incentive Compensation System Evaluation
Plan 1 (1998-2002) Although Braddock was a privately held company during this time, the long-term incentive plan involved a stock-based component (case Exhibit 4) and as well as an annual performance bonus based on the matrix illustrated in case Exhibit 6.
The good * Since management compensation is tied to firm performance, managers are incentivized to keep costs under control and maintain profitability. However, it is important to balance cost-controls with
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Since management is adjusting the book value by the growth of retained earnings in each year of the measurement cycle, they are essentially double counting this growth rate. Looking at Exhibit 4, the 2002 BVPS of $40.15 already reflects the five-year growth rate in net book value from the 1997 base of $18.65. So, including this growth rate in the performance factor only serves to inflate the end market value per share. * Since management’s estimate of the market value of equity is unaudited, this system had little credibility. Furthermore, deriving a market value of equity that way presented an easy opportunity for management to game the system in a similar way that management of public firms were known for backdating stock options before SEC legislation took effect in 2005. * From the perspective of management, stock-based compensation involves a considerable amount of risk. Depending on the proportion of total compensation that the stock options represent, a manager could suffer a significant loss of income as a result of unfortunate events that are completely unrelated to his or her own performance, such as poor macroeconomic conditions, or even war or natural disaster. When the macroeconomic outlook is positive, managers will favour stock-based compensation. However, when the outlook is negative, managers will push for higher base salaries and more certain incomes. * Another weakness in the system was that all options were