Whole Foods Market's Compensation Committee determines a portion of executive bonuses qualitatively. For the quantitative portion, the Committee selects from 13 performance metrics. For the fiscal year 2012, the Compensation Committee selected the following six quantitative performance criteria, formulas, and relative weightings:
1- Comparable store sales growth $5,000 is earned for every 10 basis points of improvement, and the total is multiplied by 20% to weight this portion of the quantitative bonus amount.
2- Year-over-year improvement in EBITANCE For every dollar of results, $0.005 or 0.50% is earned, and the total is multiplied by 20% to weight this portion of the quantitative bonus amount.
3- NOPAT ROIC $8,000 is earned for every 10 basis points of return, and the total is multiplied by 20% to weight this portion of the quantitative bonus amount.
4- Year-over-year improvement in EVA For every dollar of results, $0.0175 or 1.75% is earned, and the total is multiplied by 20% to weight this portion of the quantitative bonus amount.
5- Positive free cash flow For every dollar of results, $0.0015 or 0.15% is earned , and the total is multiplied by 10% to weight this portion of the quantitative bonus amount.
6- Year-over-year improvement in average store development cost per square foot $5,000 is earned for every 10 basis points of improvement, and the total is multiplied by 10% to weight this portion of the quantitative bonus amount.
Comparable store sales growth represents growth in sales from stores open for the entirety of the current period and the comparison period. EBITANCE is earnings before interest, taxes, and non-cash expense. Noncash expense includes depreciation, amortization, fixed asset impairment charges, noncash share-based payment expense, deferred rent, and last-in, first-out (LIFO) charge. NOPAT ROIC is net operating profit after tax divided by total invested capital. EVA is economic value added, which is described in this chapter. Positive free cash flow is cash flow from operations minus capital expenditures.
Whole Foods does not use stock price performance as a factor in determining annual cash compensation. However, the company believes a relationship exists between stock price and team members' performance, so that its compensation plan is designed to reward team members for positive stock price performance.
Required:
1. Compared to GAAP earnings, what advantage does EVA provide as a performance metric for incentive compensation purposes? Why might this advantage be particularly important for companies such as Whole Foods Market?
2. Explain why Whole Foods Market does not use stock price performance to determine annual compensation for its executives. What mechanisms other than annual compensation might the company use to encourage managers to create shareholder value?
3. What impact (if any) does EVA use have on earnings management? In other words, will managers be more likely or less likely to use accounting tricks to achieve EVA bonus targets than is the case for traditional GAAP earnings targets?
4. Explain how the EVA pool works and why it might help overcome management's tendency to focus on the short term.
5. How does usinga weighted-average of six performance metrics alter an executive's behavior relative to if he or she faced a single performance metric?