Final Exam CorpIncentives

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University of California, Los Angeles *

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Management

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Feb 20, 2024

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1. FOX and Bones a. Decentralization and transfer pricing b. FOX was running a scheme with its affiliates (Hulu) where it was undercharging fees and licensing to air the show “Bones”. This was making the overall profitability at Hulu appear higher than it necessarily should have been. This could have been remedied by decentralization within the FOX conglomerate. FOX had a 30% stake in Hulu and executive Dan Fawcett signed the deal on behalf of both Hulu and FOX. This kind of overlap encouraged transfer pricing that benefited Hulu at the expense of FOX, which ultimately stood to benefit from growth in Hulu. By keeping the two entities decentralized, pricing would face more market dynamics and be less impacted by conglomerate-wide schemes. Wells Fargo Fraud a. Goal Congruence, managerial myopia, and non-financial performance measures b. Employees at Wells Fargo were opening fake accounts to inflate their performance metrics. This problem stems from non-financial performance measures and short-term thinking (managerial myopia) leading employees to open fake accounts. These accounts did not drive the financial performance of the firm itself and represented a lack of goal congruence between management and the firm. The bank should have been incentivizing its workers based on metrics that led to the financial success of the firm. After all, a fake account was essentially driving no additional revenue to the bank. A two- step approach, such as accounts opened with a minimum balance met, would incentivize not only non-financial performance but financial performance as well. 2. a. Raz Paz Overhead (200 setups) 2,000 $ 8,000 $ Variable Cost 7,500 $ 10,000 $ Total Cost 9,500 $ 18,000 $ Units 500 2,000 Price/Unit 19 $ 9 $ b. Going purely off the price/unit data from a., the choice will be to go with Plan (1). As the price/unit from a. of Paz is higher than the revenue/unit, the two options (2) and (3) that include production of Paz result in a lower overall profit. c. i. Raz Paz Set Ups 100 100 $/Set Up 50 $ 50 $ Overhead 5,000 $ 5,000 $ Variable Cost 7,500 $ 10,000 $ Total Cost 12,500 $ 15,000 $ Units 500 $ 2,000 $ Price/Unit 25 7.5 ii. Under this data, Plan (3) would be the choice as this would result in the highest overall profit as the Paz units are no longer driving a loss.

d. Because the Raz units are constant in both Plan 1 and Plan 3, Plan 3 will always be better if Paz profit margin is positive and worse is Paz margin is negative. Even if all the overhead was allocated to the production of Raz units, the total profit of Plans 1 & 3 will be greater than Plan 2. As such, the allocation of overhead will determine if the more profitable option is Plan 1 or if it is Plan 3. e. ABC is not flawed. The method of using machine hours to determine the allocation of overhead assumes that the number of set ups is associated with the number of machine hours, which may not always be true. In this case, the ABC method seems to more accurately allocate overhead. 3. 1. This plan rewards Tim for profitability metrics of the overall firm but the marketing division itself may only represent revenue/cost to the firm-wide P&L. As such, Tim will benefit/lose out from performance of other divisions not under his control. 2. The plan is short-term aimed and may lead Tim to engage in activities that don’t serve the firm’s best interests. 3. As this is based off of profitability, it may deter Tim from undertaking investment opportunities that may lead to greater profitability in the long-run. 4. The plan does not acknowledge any non-financial metrics that Tim may be performing well in. These metrics may lead to profitability down the road. To accurately assess and reward Tim’s performance, the firm will need to separate out the financial performance of the marketing division from the firm and reward/incentivize success over the long run. My recommendation is to establish an Economic Value Added program within the firm. This will keep the divisions separate while accounting for long-term value added by individual performance. It also will not deter Tim from making investment decisions as the capitalization and amortization of costs will encourage spending.

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