Division manager's compensation, risk sharing, incentives (continuation of 24-30). The management of Summit Equipment is having problems implementing a complex bonus scheme and was forced to award only the base bonus calculated as 2% of operating income. For the immediate future management is considering the following alternative compensation arrangements:

REQUIRED 1. Assume that the divisional managers are risk averse. Using concepts of performance evaluation described in this chapter, evaluate each of the three proposals that Harrington is considering.
Indicate the positive and negative features of each proposal.
2. What compensation arrangement would you recommend? Explain briefly.LO1

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Make the managers' compensation a fixed salary without any bonuses. Ben Harrington, Summit's president, believes that one advantage of this arrangement is that the division managers will be less inclined to reject future investments just because of their impact on operating income. Make all of division managers' compensation depend on the division's RI. The benefit of this arrangement is that it creates incentives for them to aggressively seek and accept all proposals that increase the divisional RI. Evaluate managers' performance using benchmarking by comparing the divisional RI against the RI achieved by managers of other similar companies in terms of size, volume, products, and investment. Harrington believes that the advantage of benchmarking is that it focuses attention on divisional performance relative to peers rather than on the divi- sion's absolute performance.