Alternative Compensation Plans ADM, Inc., an electronics manufacturer, uses growth in earnings per share (EPS) as a guideline for evaluating executive performance. ADM executives receive a bonus of $5,000 for every penny increase in EPS for the year. This bonus is paid in addition to fixed salaries ranging from $500,000 to $900,000 annually.
Cygnus Corporation, a computer components manufacturer, also uses EPS as an evaluation tool.
Its executives receive a bonus equal to 40 percent of their salary for the year if the firm's EPS is in the top third of a list ranking the EPS for Cygnus and its 12 competitors.
Required
1. Why are companies such as ADM, Inc., and Cygnus Corporation switching from stock option incentives to programs more like the ones described? What does the use of these plans by the two firms say about each firm's competitive strategy?
2. What are the weaknesses of incentive plans based on EPS?