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ACCA Strategic Professional · Advanced Performance Management · Performance and reward

Halvern plc's remuneration committee is redesigning the bonus for its CEO. The bonus is currently 60% of salary if EPS growth exceeds 8%, and nothing otherwise. Forecast EPS growth is 7.6%, and the CEO is considering a share buyback funded by debt, which would lift EPS growth to 9.1% while increasing financial risk and reducing cash available for investment. Which redesign would best address this problem?

The best redesign is to add a return-based or cash-flow measure and use a sliding scale instead of a cliff-edge. This reduces the incentive to engineer EPS through a debt-funded buyback, because the bonus no longer depends on a single easily manipulated threshold.

  1. AAdd a return-based or cash-flow measure such as ROCE or free cash flow, and use a sliding scale rather than a cliff-edge thresholdCorrect
  2. BRaise the EPS growth threshold to 10% so that it is harder to achieve
  3. CReplace the bonus entirely with a higher fixed salary
  4. DPay the bonus in cash immediately after the year-end to improve motivation

Explanation

The all-or-nothing EPS threshold creates an incentive to manipulate EPS through leveraged buybacks near the threshold. Adding a measure less easily manipulated by capital structure (ROCE or cash flow) and using a sliding scale reduces the cliff-edge incentive. A higher threshold would increase the pressure to manipulate, and fixed salary removes the performance link.

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