King Engineering Group Case Study on Management Controls

1.?Analyze the case

2.Evaluate the performance measurement and incentive systems used in King Engineering Group. What changes would you recommend, if any?

3.What are some critical success factors?

433 were icant King Engineering Group , Inc. ` ," which involved financing , engineering , pro- In light of these changes , King developed a strategy of In the late 200 0s as a result of the great recession , King's organization structure also included three about 25% of total company sales , but a buyer had not intention to sell the E&C Group , which generated curement , construction , operation , and maintenance* poorly ) and an acceleration of the shift ( particularly in tions . In October 2015 , the company announced an capabilities on a global scale . These changes required company instead moved to try to deliver more " turnkey* market ( Europe , Middle East , Africa & South Asia some significant changes . These included firm consoli - ( EMEASA ) ; Latin America ; and Asia Pacific ) . King's energy and chemicals markets ) from cost-plus con- dations ( mainly because many firms were performing tracts toward fixed- price business . King , which tradit regional organizations beyond its North American coordinate King's in-country resources with local partners , and to mobilize King's global workforce to and developing greater marketing efforts . Over time , ting costs , outsourcing non-critical engineering skills , _neering , construction , and program management . The the engineering and construction industry underwent* tionally had been among the more conservative delivering more than traditional ( " blue - collar " ) engi - players in the industry , responded successfully by cut- based on fixed- price rather than cost-plus contracts , provide the technical capabilities required on the projects totaled about 200 in the Transportation Group , business units to support international customers , to encompassed approximately 3 , 000 projects , the budget treatment plants . In a typical year , King's operations King had also restructured its corporate business port - King to bear more risk . Since more of these projects w regional management worked closely with the glo` for some of which exceeded $ 1 billion . The significa 60 - 70 in E & C , and 200 in [& T .* yet been identified ." solutions , " W/ projects . Oklahoma , but it's operations were global . King had folio through both internal development and acquisi - tion facilities , and chemical plants . The Infrastructure !` our owners reasonably expect ? Should we com -\\ & Technology ( [& T ) Group ( 40%/0 ) built projects in 16\\ and construction assets . What performance should* funds just happen to be invested in engineering* King was headquartered in Oklahoma City ,\\ mental services , such as the monitoring of air and* water quality and construction of municipal waste* pare our performance against that of our publicly* traded competitors or other pension plans ? And* an investment maintained by a pension plan ; the* ing toward the achievement of our corporate goals ?* Our goal , like that of all corporations , is to maxi - mize value for our investors . But King is essentially* how can we best get all of our business units work - three main business units ( see organization chart in* George E . King founded King Engineering in 1946 . By* somewhat unique because King was privately owned* different market sectors , including shopping centers , corporate and business unit goal setting . Their task was\\ ing and construction firm , with over 1 1 , 000 employees* 2016 , Jim Anderson , King's chief financial officer* Exhibit 1 ) . The Transportation Group ( approximately\\ ( [& C ) Group ( 40% ) offered design and construction* dams , . resorts , airports , and telecommunication* the year 2016 , King was a large full-service engineer -\\ services for oil and gas field refineries , power genera - 20% of total company sales ) built highways , bridges , and rail and transit systems . The Energy & Chemicals infrastructures . The [& I Group also provided environ - pany , were striving to strengthen the links between* In early 2016 , managers at King Engineering Group , Inc . ( King ) , a large engineering and construction com - by an employee stock ownership plan ( ESOP ) . In May King Engineering Group , Inc. and nearly $1 . 5 billion in annual sales .* ( CFO ) , described the challenge :" CASE STUDY The companyployee tracts their `` bondsinhere fromyes` revenue from contracts booked during a period over* ESOPS also provide advantages in that they give Gross Profit Sold ( GPS ) : the excess of anticipated Despite the advantages of the ESOP , not all of the In its early years , King's managers' main focus In the early 200 0s , when a new management team! ately benefited higher- level executives , and that the employees were happy with the change in ownership . groups filed a class action lawsuit against King and its officers and directors . They maintained that they had buyout left the ESOP with all of the debt but none of the* little say in the decision , that the plan disproportion - The generic income statement used in the construction ing revenue trends and revenue-based ratios . Some* pany . This ownership stake can improve the company's reflected only the smaller amount of revenues focus . They made greater use of the following four* earned significant royalty payments but had no decision - making power . The final appeal was heard in was on the revenue line . The problem with this proportionally good margins . For yet others , King* employees a significant ownership stake in their com - in which King was involved often produced mislead - of King's contracts , such as some oil exploration pro - jects , were set up to run all the revenues generated earned directly from King's efforts , which yielded flowed to the client's records , and King's records minus : Direct contract costs ( materials , labor , and overhead) was very small . In others , all project revenues* When the King ESOP was formed , several employ assumed control , King's managers changed to approach was that the varying mix of the contre Accounting performance measures minus : General and administrative expenses ( G&A ) 1991 , and the settlement favored King's position ." culture and lead to performance gains .* anticipated direct contract costs ." industry is in the following format :" = Net operating income costs associated with them .\\ Gross profit Revenues* measures :" taxable income . This gave rise to so- called " leveraged but King's profit as a percentage of those revenues 50 % of the interest earned on loans to ESOPS from its by the project through King's accounting records , eering had only one share* Chapter 10 . Financial Performance Measures and Their Effects ESOPS ," such as that in place at King , and used as an* important element of corporate finance . In a leveraged* ESOPS are employee benefit plans that make employ - tax deductible . Moreover , when King's ESOP was* ESOP . The ESOP can use the funds to buy either existing* create liquidity for the original owners and to take\\ projects , King was even providing customers with " back -\\ ESOPS provided two tax-related advantages . First , existence in the United States covering about 13 . 5 million employee end guarantees . " For example , the customers would buy* ESOPS are quite common . In 2015 , the National Center for Employee* owners ( or about 8. 5% of the US workforce ) . For more information* King had always been privately owned . But in 1984 , to| formed , US federal tax law allowed lenders to exclude* Ownership estimated that there were approximately 7 , 000 ESOPS in other qualified lender and then , in turn , lends it to the ing the performance risks . In some of the projects , the ([SOP ) and had the ESOP buy all of the company stock .* since ESOP contributions are tax deductible , a corpora - principal as well as interest from taxes . Second , divi -\\ kets forced the lenders to pass some of these savings on ,\\ ESOP , the company borrows money from a bank or* stock or new stock from the company . Competitive mar -\\ King bore the cost - control and schedule risks . In some* ing for construction of a power plant , so King was bear - advantage of some newly created tax changes , King's* managers created an Employee Stock Ownership Plan dends on ESOP stock that are paid to employees are also ees of a company the owners of the stock in that com - pany* ESOPS are required by law to invest primarily in the securities of the sponsoring employer . All employ - ees are automatically members of the ESOP , and they build up a " beneficial interest " over time . King employ - ees' ESOP interests are fully vested after seven years , tion that repays an ESOP loan in effect gets to deduct* SO ESOPS were able to borrow money at favorable rates . 2 kilowatts from King at a fixed price , rather than just pay- and they receive a lump sum payout at retirement . Ownership by an Employee Stock risks were shared with a joint- venture partner .* 2 This provision in the tax law no longer exists . Ownership Plan ( ESOP ) After 1984 , King Engineer ! on ESOPS , see www. esop . org .\\ holder : the ESOP trust .* 434Y out it our osest al are 439 could King Engineering Group , Inc . If we shed our E &C business , we will have more Second , to what extent should we consider our* Third , is there a flaw in this whole system ? The control over the LTIP rewards because what will be* left in the corporation will be more predictable . It won't be as affected by the swings in oil prices . So there will be a lot more accountability on our part . " change attitudes towards more of a King mentality ," would also say that the LTIP is a powerful tool to somehow connected to oil production , are doing We are a relatively old company ; the average age of need ? Or should we consider what other pension of our share price targets ? We have tended to com - thinking instead about what return our investors industry competitors , but 50% of the firms in this industry , particularly those whose business is shareholder groups ' retirement needs or concerns ?' our employees is 47 . But we're really comprised of about the pension plan at all , is willing to tolerate* two significant age groups . We didn't hire much in based on very few data points . If we could retrofit plans . A 59 - year- old engineer wants low risk . A return . How should we blend these concerns ?' money ? We also have 6 , 000 ESOP participants who relatively poorly at the current time . Should we be the early 200 0s when our business was not doing well , so the 36 - 45 age group is largely missing . Age* 25 - year - old , on the other hand , if he or she thinks high risk in exchange for a high expected long-term makes a big difference in thinking about pension the sales - to - share - price model using real , histori - cal data , but taking out the effects of the structural the business unit managers to find ways to drive share* First , is there some way to take the subjectivity & it's attempts to translate the share price concerns of its retirees or near - retirees into measures that would drive* pare our performance with those of our clos parameters in the sales - to- share price model ? Jim Anderson thought that King had made progress in price . But he knew more work had to be done , and he Should these concerns affect where we invest* are no longer employed at King . How highly sho plans or investment funds are providing ?" had some significant questions and concerns :" so it's good from that standpoint ." we weight their concerns ?` Concerns for the future setting . Although rewards are capped , exceptional people get to 120% or more of their target , then performance can always be taken care of through The primary performance criterion in the LTIP was* there is clearly something wrong with my target* The payments vested over the three years following* This is truly " blue smoke and mirrors . " We don't think about it as much as we do about the MIP . I understand the payouts from the LTIP can be very ple were included , roughly down to one level below the* significant , and people who are in the plan are* share price are relatively small . If the market is up vate them to exert maximum effort to achieve the cor -* paid in cash , were based on three - year performance . In* King's share price growth . In each new performance* Bill Houchin believed that the LTIP was less of an grateful . But I look at the potential awards as a and we happen to be in a window that allows us to 2014 , When the [TIP was first adopted , about 70 - 80 peo -\\ windfall . After all , our individual impacts on King's poration's long-term goals . LTIP awards , which were* The LTIP was designed to encourage key employees of the corporation to remain in King's employ and to moti - ( depending on organizational level ) . A performance the completion of a performance cycle at the rate of cycle , each individual included in the plan was awarded a substantial number of performance units after they vested . A new performance cycle started* the event certain performance criteria were achieved . might not be granted performance units for a different unit was a contingent right to receive a cash amount in of employees who would participate in the plan , the granted to each participant , and the performance cycle or cycles . NO LTIP payments had yet been made For each cycle , the board of directors decided the list value of a performance unit , the number of units to be ously . A participant in any cycle , however , might or each year , so three cycles were in progress simultane- because the first performance cycle , which started in incentive plan and more of an attempt to replicate the one - third per year . Payments were made in January stock option plans used in publicly traded companies :" managers of the major profit- and - loss units .* take advantage of it , then that's great .* Long Term Incentive Plan ( LTIP ) discretionary bonuses . 2014 , was not yet complete . criteria / targets .*(% Exl Tar 4King othe Exh of w grov Ridofim nath disim nivak toiduf by nob all bsineis Brie sifit gritteasy moned ASIA PACIFIC e CFO - James T. Anderson e HUMAN RESOURCES e GENERAL COUNCIL & CONSTRUCTION "size" measures, for example, do not reflect the use Some critics have pointed out that the current and that GPS lags sales effort (although it is a good more important. So I don't know if it's a financial of assets and their ability to generate cash flows leading indicator of future GPP and NOI). Okay, but the denominator? We need to look broader than lectual capital, not just receivables. Some others not fully activity-based, and at times in the past based prices to be non-competitive. And some if we use return-type measures, what should be in financial assets. Our value is in people and intel- have argued that we should be looking at some measures of political involvement, public relations exposure, joint efforts, and win rates. There are lots they believe this has caused some of our cost- non-financial performance measures, such as have pointed out that our overhead numbers are INFRASTRUCTURE & KING TECHNOLOGY GROUP William C. Houchin of things we might be working on. calculation we need. Jim Anderson agreed: EUROPE, MIDDLE EAST, AFRICA, SOUTH ASIA KING CHAIRMAN and CHIEF EXECUTIVE OFFICER KING GROUP TRANSPORTATION Chapter 10 . Financial Performance Measures and Their Effects KING LATIN AMERICA good return measure for our profit centers. We generate meaningful results? Would this model work in another industry? I want to be able to go to the board and explain that we have not just I think our biggest problem is that we don't have a Some other King employees, particularly those with need to work on an ROA measure. Right now there For example, I used to think we were investing too changes in our business over the years, would we is no way to assess an investment or exit strategy. are not the key. Intellectual assets - people - are to a commodity business. Now I am happy that it is seen as a commodity business. But financial assets much in Chemicals which, I thought, had changed about the exclusive reliance on financial volume meas- like Return on Assets (ROA), or even a broader set of financial and non-financial measures. The manager of some financial sophistication, were also concerned ures like GPS, GPP and OH, instead of return measures E&C's Global Business Development area elaborated: Exhibit 1 King Engineering organization chart ENERGY & CHEMICALS KING GROUP dreamed this up. 440441 King Engineering Group , Inc . 2016 ( plan ) 17.6 $22.38| 12 , 476 41 , 699 5 , 000 13, 000 78, 500 53 , 024 51 , 520 21, 980 $933 , 224 Target achievement 1 10% 100 % 17 , 893`^ 2015 ( actual ) 17.6 46 , 109 5 , 000 other ESOP companies . Excess ESOP was an adjustment made by the valuation consultancy to compare King with its major competitors that , regardless 41 , 699 15 , 000 $19.46 10 , 849 71, 959 * King's contribution rate to the ESOP was approximately 15 - 20% of eligible compensation , which was significantly higher than the typical 6 - 8% range in 49, 066 Exhibit 2 King Engineering illustration of sales-to- share price model calculation assuming a desired 15 % $871 , 1 90 % Exhibit 3 King Engineering illustration of the MIP reward function used in the 1& T Group This case was prepared by Professors Kenneth A . Merchant and Wim A . Van der Stede . of whether they are ESOPS or not , typically returned a lower proportion of earnings to shareholders ." : 710 % of target bonus : ( 27.5 % of salary ) : 100% of target bonus : ( 25 % of Salary ) Copyright @ by Kenneth A . Merchant and Wim A . Van der Stede ." - excess ESOP contribution* * # shares outstanding = capitalization value growth in share price* + interest expense - other income - P / E multiple Price / share = earnings Target bonus ( %/0 of salary ) = EBIT = NOI + tax