Marshall School of Business
University of Southern California
Rev. 10-28-06
Industrial Electronics, Inc.
Teaching Note
Purpose of Case
This case, which is really a short vignette, was written primarily for exam purposes in situations
where the examination time is short. But the case can also be used as the basis for a class
discussion.
Suggested Assignment Questions
Here are the questions used in the exam setting (importance weightings assigned to each
question are shown in parentheses):
(20%) 1. Calculate the bonus award (as a percent of base salary) that would be given to the
manager of each of the following four divisions under the proposed new bonus
system. These divisions are representative of the range of divisions within IE.
($000)
Division Budgeted
Operating Profit
Budgeted
Operating Assets
Actual
Operating Profit
Actual
Operating Assets
A $1,000 $8,000 $1,150 $7,000
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
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(20%) 2. Evaluate (i.e., discuss the pros and cons of) the current bonus system.
(30%) 3. Evaluate the proposed bonus system.
(30%) 4. Propose a bonus system that you believe is optimal for IE. Why do you think your
proposed system is optimal? Explain.
Discussion
Question 1
Question one forces the students to apply the description of the new system to a hypothetical
Question 2
Question (2) asks for an evaluation of the current (old) bonus system. This system provided
managers with bonuses based on a share of overall corporate profit after taxes in excess of 12%
of book net worth.
Advantages of the current system
1. It is a wealth sharing system. If the company does well, all managers do well, and vice
versa. The company has to make larger payouts when it is best able to do so.
Disadvantages of the current system
1. Except for the highest level of managers, corporate performance is largely uncontrollable.
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4. There is no charge for the use of assets that are financed by debt, in the sense that the asset
5. The bonus cutoffs, both at the bottom (corporate performance below 12%) and the top
(maximum bonus of 150% of salary), are potentially bad:
Question 3
Question (3) asks for an evaluation of the proposed new system.
Advantages of the proposed new system
1. The measures are more controllable. Division managers will be held accountable for
2. The awards are based on an economic profit, or residual income, performance measure.
Managers would be charged for tying up assets in their business.
4. The performance targets would be tailored to each business unit. Presumably they would be
Disadvantages of the proposed new system
1. The performance measures, which are accounting-based, are short-term oriented. This could
2. The measures are just uniform, summary results indicators. They are not at all linked with
3. Cash is arbitrarily assigned to the operating units. Why?
4. Charging for fixed assets based on net book values causes well-known problems. Among
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5. There seem to be no adjustments made based on whether the company leases or owns fixed
assets.
7. Bonuses can be paid even if the company or division is losing money. Is this fair to the
shareholders?
8. There is still a maximum bonus cutoff 150% of salarysee Example Division B), which
could cause demotivation and gamesmanship.
10. Budget targets are difficult to set equitably in uncertain environments such as IE operates in.
12. Under the new system, bonuses will probably be paid even when an operating unit is not
making its profit target (see example Division E). Is this desirable, particularly when the
targets are set to be highly achievable?
13. Organizational interdependency seems to be small, but to the extent that divisions have to
14. Is the new plan too complex? Will the affected managers understand it?
Question 4
Question (4) asks for student recommendations. In answering Question (4), students must try to
address as many of the weaknesses of the new system as they can while retaining the
Pedagogy
This is a short case. However, because it contains descriptions of two incentive plans and raises
so many issues, the discussion of it can easily consume an entire class period, of 75 minutes or