The Corn Products plan links bonuses "to what it takes to earn a profit on sales," asserts Beebe. "It's great to make a sale, but if it takes 120 days to collect the money, profit margins won't be very sturdy, and that's not the business model we want to encourage."
She emphasizes that managers still have an incentive to make the right business decision, "but there are tradeoffs now." For example, if a unit manager wants to build inventory because he believes sales will be stronger next quarter, he should proceed with the build-up. But if the assumption turns out to be wrong, the working-capital portion of his bonus will be penalized "because he placed assets on the balance sheet without earning a return."
"Yes, it's tough love," says Beebe, "but it's a balanced approach." She notes that unit executives can choose to manage their working capital by concentrating on payables, on receivables, or on inventory. In addition, the targets — for example, days sales outstanding or days inventory outstanding — are set not in a vacuum, but rather with input from local management teams.
It's Not for Everyone
Improving cash flow is a natural for large manufacturers that have significant capital expenses and depreciation. At General Electric, says company spokesman Gary Sheffer, cash flow has always been "a very important metric."
Not all companies are interested in linking bonuses to cash flow, however, says Clark Consulting's Wamberg. Although many analysts want to see more financial reporting on cash earnings, smaller companies tend to be hesitant about changing their shareholder reporting metrics, which tend to be based on earnings or net income.
In addition, smaller companies with an intense focus on cash flow run a risk when they improve their working capital — they many squeeze their clients and vendors. That's a surefire way to hurt business relationships and impede quality and service, says Robert Williamson, a former CFO and now the chairman of privately held CityMerch Corp. in Miami Beach. Although Williamson agrees that cash-flow numbers are harder to manipulate than EPS or revenue, he maintains that the gaming can't be stopped completely — there always will be attempts to "starve cash flow to [manipulate the metric], in much the same way channels are artificially stuffed to improve earnings."
Another caveat, says Mercer's Miller, is that linking bonuses and cash flow may sidetrack high-growth companies, which usually seek to reinvest cash to spur long-term growth. If bonus payouts are based on improvements in cash flow, opines Miller, managers may cut costs and underinvest in the business.
A Spoonful of Sugar
Connecting compensation and cash flow is not a cure-all for corporate scandals or dysfunctional business behavior. But it does steer executives toward a more holistic approach to management — from "managing only for the profit and loss statement toward managing for capital and the balance sheet as well," contends Miller.
Achieving that balance also can work nicely as a risk management tool for protecting annual bonuses, especially when control for making the numbers may be taken out of a manager's hands. Witness the Corn Products divisional bonuses that were almost completely wiped out, had it not been for its ties to cash flow.
On January 1, 2002, the Mexican Congress imposed a 20 percent tax on beverages sweetened with high-fructose corn syrup 55 (HFCS 55). The idea was to encourage local bottlers to use domestic sugar, rather than imported sweeteners. The strategy worked: The tax hike effectively raised the cost of a US$1.00 can of Coca-Cola to US$1.20, and Mexican bottlers promptly abandoned HFCS 55.
Corn Products, which makes HFCS 55, took a big hit that year. Operating income sank 14 percent — from $65 million in 2001 to $56 million in 2002 — and earnings per share dropped 38 percent.
As a result, the bonus-eligible employees working in the division that manufactures HFCS 55 were headed for a big disappointment; based on the decline in operating income, they were not scheduled to receive a bonus payout. Fortunately, the division had contributed to the company's $65 million working capital improvement, and employees were awarded the 20 percent of their bonus that was linked to working capital.
That 20 percent might not seem like much, but had Corn Products not connected compensation and cash flow, it would have been the Mexican Congress that determined those bonuses. Seen in that light, you might even say that Corn Products gave their employees a sweet deal.
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