China Resources Corp. (A): 6S Management Case Solution

1. What is Jiang Wei trying to accomplish with the incentive systems, i.e., performance contracts and EVA-based incentive plans? Does CRC need both incentive systems? Why or why not? Hint: Identify what each system is accomplishing.

In the performance contract, the employee is evaluated using different perspectives of the firm and each perspective is assigned a weight according to its importance. The Manger may earn up to 70% bonus if they are able to fulfill the objectives of the contract. This means that the employee will work hard to earn these bonuses by trying to increase the earnings without compromising on other factors like customer satisfaction and internal processes. The remaining 30% of the bonus is tied to the individual manager appraisal. This guarantees that managers also behave appropriately and within the code of conduct of their position.

Economic Value added (EVA) based incentive system was a longer term incentive system which helped empower managers to be responsible for the return of their cost centre and retain them in the long run. As the purchased shares from the share of operating profits were held in the trusteeship of the company for three years, managers were tempted to stick with their job for at least three years. With the EVA based incentive plan, Jiang Wei Is trying to aligning the performance of management with the shareholders’ value. He also wants managers to be concerned about the cost of capital of their respective cost centers.

Both the performance contracts and EVA-based incentive plans gives the firm strong wealth leverage to make sure that the employees work diligently and take appropriate decision. This is mainly done to eliminate agency problem. Agency problem is caused due to differing objectives of manager and the shareholders.

Both of these incentives are necessary and not redundant. As described earlier, both of the incentive plans serve a different purpose. Performance contract aims to ensure that mangers try increasing profitability of business while simultaneously working in the best interest of the company. On the other hand, EVA based incentive plan focuses on retaining the managers and to make them take cost of capital into account.

2. Would managers behave differently if the performance contract were eliminated? Why not use the EVA-based plan to provide incentives and balanced scorecards to provide information?

The managers will undoubtedly behave differently if the performance contracts are eliminated. The biggest advantage of the performance contract is that it provides bonuses after considering all aspects of the business. This means that the performance is not measured based on the returns only but also the internal processes management and customer satisfaction. For this reason, managers will try to increase profits considering all other perspectives as well. However, if this incentive system is eliminated, managers, who will have the objective to maximize bonuses, will try to compromise on other aspects like quality and customer service to decrease the expenses in order to increase profits. This will drastically affect the business in the long run.

Balanced Scorecard is particularly useful for measuring performance of a profit centre. Once the performance is measured, the management will suggest the objectives that each profit centre has to attain in order to improve the balanced scorecard performance. However, if EVA based incentive system is used, the managers will not take the objectives seriously. This is because this incentive system would not provide the employees and managers the incentive to improve their performance as per the balance scorecard performance measurement. EVA based incentive system only measured performance taking into net operating profit after tax (NOPAT) and the cost of capital. It totally ignores the fact that the future profitability of the firm is also based on other aspects discussed earlier. If the employees and managers are not given permanent contract incentive, they will not give importance to balanced scorecard performance measurements and will not work towards improving it.

3. In the last two paragraphs on page 10 of the case, CRC Chief Financial Officer Jiang Wei identifies his concerns going forward. Do you share his concerns? If so, what recommendations do you have to ensure that CRC does not become too inward focused?

After the implementation of the 6S management system and the incentive plans, the CFO, Jiang Wei, do not have any reason to feel concerned about the future prospects of the business.