Jerry

Lecture Illustration: Compensation

Salt Water Ltd.

Salt Water Ltd is a large and successful manufacturer of engines. The company consists of two divisions: the Automotive Engine division and the Outboard Motor Division. Salt Water has recently acquired a new company which will become a third division. The new Couch division is a small manufacturer of lawnmower motors. It has been owned and managed by the one person for 40 years. The prior owner treated all employees as part of his family. The company was noted for the lack of a ‘them and us’ attitude between employees and management, and there was free and open communication between all staff. Unfortunately, Couch is not a strong performer; the lawnmower market is in decline and profits have slipped.

Salt Water is known for its modern management systems and would like all managers at Couch to participate in the performance-related pay system that is used in the other two divisions. The profit-sharing plan applies to senior divisional managers only. It is based on placing 10 percent of Salt Water’s profits before interest and income tax into a pool, which is then shared by the senior divisional managers in direct proportion to their base salaries. The senior managers in the two original divisions received bonuses of 11 percent and 12 percent of their salaries in 2005 and 2006 respectively.

The profit results for 2007, the first financial year following the acquisition of the Couch Division, are as follows:

| Outboard | Automotive | Couch |

Sales revenue | $8 000 000 | $10 000 000 | $2 000 000 |

Cost of goods sold | 4 000 000 | 6 000 000 | 1 500 000 |

Gross margin | $4 000 000 | $4 000 000 | $500 000 |

Administrative costs | 1 200 000 | 900 000 | 300 000 |

Marketing and selling costs | 1 600 000 | 900 000 | 100 000 |

Total costs | $2 800 000 | $1 800 000 | $400 000 |

Profit before interest and taxes | $1 200 000 | $2 200 000 | $100 000 |

Senior...