Ethics and Performance-Based Compensation
The executive officers of the Fancy Expensive Wine Corporation have a performance-based compensation plan. The performance criteria of this plan is linked to growth in earnings per share. When annual EPS growth is 12%, the Fancy Expensive Wine Corporation executives earn 100% of the shares; if growth is 16%, they earn 125%. If EPS growth is lower than 8%, the executives receive no additional compensation. In 2003, Nancy Noseup, the controller of the Fancy Expensive Wine Corporation, reviews year-end estimates of bad debt expense and warranty expense. She calculates the EPS growth at 15%. Peter Peters, a member of the executive group, remarks over lunch one day that the estimate of bad debt expense might be decreased, increasing EPS growth to 16.1%. Nancy Noseup is not sure she should do this because she believes that the current estimate of bad debts is sound. On the other hand, she recognizes that a great deal of subjectivity is involved in the
computation.
I would say that Nancy Noseup recognizes that altering the estimate will benefit Peter Peters and other executive officers of the company. Current stockholders and investors will be forced to pay out the bonuses, with the altered estimate as a critical factor. Do you agree or disagree?