Berkshire Case Analysis

Berkshire is a decentralized corporation, it uses result and personnel control. The company measures managers’ performance, provides bonus and training sessions. All four operating divisions are incentive program because they are responsible for acquisition. Berkshire used EPS to measure managers’ performance and found EPS cannot reflect shareowners’ interest. As a result, they started uses CLA approach which is a tighter result control than EPS. Berkshire also used bottom-up budgeting process and “Profit reserve”. However, by using “profit reserve”, as a public traded company, Berkshire hide key financial information from investors.  

The first issue is CLA proposed “economic profit” system based on Economic Value Added (EVA) model is not fairly measure the performance of Berkshire. The completed EVA model for CLA approach identified over 100 adjustments, but the company only using two of them to “keep the model simple”. Under the CLA approach, the consumer advertising expenses and goodwill expense for the current year was added back to operating profit and capitalized amount to net operating assets. The delay the recognition of expenses by recoding the expense as a long-term asset will increase the adjusted NOPAT and further increase the economic profit in short-term but not benefit the shareowner essentially. Therefore, the increase in economic profit does not increase the stock price of the company. We also analyse the problems of EVA model such as poor indicator for future growth, understandability failure and cost of training sessions. Overall, the recommendation of this issue is modifying some adjustments and add more stock price related measurement.

The second issue is CLA consultants against a stock-based incentive program. We have 3 alternatives. The first alternative is provide stock option plan to all managers. The second is provide restricted stock plan to all managers. The third one is keep against implementing any stock-based incentive programs. Both stock option plan and restricted stock plan have similar effect: motivate managers, tie managers’ interest with company stock price and retain talent managers. Providing stock option plan, Berkshire might have some potential future share issue.

Restrict bonus plan will conflict with current share owners’ interest. If Berkshire keep against the

Implementation of stock-based incentive program, it might demotivate managers and cannot reflect shareowners’ interest.

The third issue is the performance-setting method involved in the CLA system. Performance targets were automatically ratcheted down(up) by 75% of the prior-year’s amount without considering the company’s actual financial condition and external economic environment. Moreover, the Spirit Division suffered discouragement and demotivation due to the failure of meeting the unrealistic target set by using this method. In order to solve this issue, we figured out three alternatives. First is, adjusting the target-setting method annually at each year-end. The second alternative is, keeping these method in the CLA system unchanged. The last alternative is only adjust it when management consider is needed. After discussing, we think the third one is effective and efficient, which suits company’s situation the best.

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