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As a member of the company's compensation committee, you've been asked to comment on the following proposed changes to the annual bonus plan

The top five executives at Marvel Manufacturing are paid annual bonuses based on predetermined earnings goals. These bonuses can be as much as 500% of salary. As a member of the company's compensation committee, you've been asked to comment on the following proposed changes to the annual bonus plan:

Use after-tax income from continuing operations as the earnings performance measure instead of bottom-line net income.
Set performance goals based on return on assets (ROA) rather than on earnings.
Set performance goals-net income or ROA- based on beating the industry average rather than using an absolute performance target.

What are the advantages and disadvantages of each suggested change?

Solution Preview

? Use after-tax income from continuing operations as the earnings performance measure instead of bottom-line net income.

Advantage
It is considering the income only from the continuing operations and not the bottom line net income. It means that it is not considering the income resulting from the reasons other then the operations such as gain on sale of assets or investment income.

Disadvantage
It does not consider the efficiency of the assets into consideration. It doesn't also compare with the industry. Thus there is no benchmarking.
Moreover it does not consider the cost of capital into consideration.

? Set performance goals based on return on assets (ROA) rather than on ...

Solution Summary

Comments indicate the pros and cons of each in bullet format.

$2.19