1.

How did Whirlpool made the transition to Economic Value Added (EVA) measures
through compensation structure?

EVA formula encourages management to optimize the use of the company’s assets—
both operating assets and financial assets. In doing so, it also serves as a “check” on
whether current market price of the stock of the company in question reflects the
operational and financial performance of the company. EVA also provides a means to
measure how the different units of a company are performing relative to one another.

Adoption of EVA as the basic metric for a company’s long-term incentive plan would
mean a shift from a metric based on stock market price to a metric based on value of the
enterprise.

Case of Whirlpool:

EVA implementation was more about changing behavior, mindsets, and the corporate
culture and driving toward new levels of performance.

Board level: Whirlpool revised and revamped the stock option grants, so they are
awarded only if the company achieves certain performance targets.

Senior management level: Annual bonus opportunity was shifted from unknown to a
clear 50% to 100% of base pay, depending on achievement of targeted corporate and
business unit financial goals and individual performance. Long-term incentives shifted
from occasional use of stock options to annual stock option awards plus new plans that
incorporated an equity focus. For exempt compensation, base pay was set at 90% of
market and total cash compensation at 110% of market payable upon achievement of
stretch targets

Plant Level: Depending on various combinations of corporate, business unit, and

individual performance, actual individual awards or bonuses could range from zero to 1
V2 times target.) In non-exempt compensation, Whirlpool eliminated corporate profit
sharing (which averaged 7% of pay) and introduced gainsharing at plant locations

For certain plant employees and engineers who are not tied to a particular business
 unit but rather focus on specific products, Whirlpool created a special ‘product
earnings’ measure that is used along with performance ratings to determine awards. For
non-exempt employees (and hourly employees at most locations), incentive pay is tied
to gainsharing at the plant location plus a new retirement savings plan with a
performance-related company match. Under the program, Whirlpool matches up to 5%
of employee contributions, depending on the company’s return on equity.

2. Can these changes strengthen shareholder value creation? Support your answer.

The shareholder value increases when Whirlpool or any other firm invests in projects
that provide positive net present values (NPV). However, companies not only need a
framework that allows them to value new investments, but also a performance
measurement system that aligns manager’s and shareholder’s interests.

While capital markets value companies and investments on the basis of future
expectations, performance measures and incentive compensation must be based on the
past. Therefore, a valuable framework has to take both future expectations and past
performance into account. While free-cash flow is a good measure for the feasibility of
an investment, it falls short on measuring performance. However, any metric should
provide a link to free-cash flow methods to ensure that performance evaluation is
consistent with the way investors value the company.

The EVA formula encourages management to optimize the use of the company’s assets
— both operating assets and financial assets. In doing so, it also serves as a “check” on
whether current market price of the stock of the company in question reflects the
operational and financial performance of the company. EVA also provides a means to
measure how the different units of a company are performing relative to one another.

3. Do you find any shortcomings in the current pay structure with respect to pay for
performance plans? Why or why not? Substantiate your answer.

EVA involves a complex formula including its application as a metric for executive incentive
programs. This is primarily due to the numerous adjustments made in the application of
conventional accounting rules in the calculation of EVA. The complexity of EVA gives rise to a
number of concerns.
1. Will executives and directors understand EVA? An incentive plan metric will not be very
effective in driving corporate performance if the participating executives and the directors who
oversee them do not understand how it works. Making an explanation of how EVA works that
is understandable to management will require a careful, and probably rather lengthy,
discussion. Presumably this discussion will be included in the award agreements. Some
companies may include the discussion in the applicable plan and incorporate it into the award
agreements by cross-reference.

2. Will shareholders be confused by the EVA figures, given that EVA is a non- GAAP financial
measure? In presenting EVA figures to shareholders, Whirlpool will have to be mindful of SEC
requirements relating to disclosure of non-GAAP financial measures.

3. Valid comparisons of EVA performance among different companies may be difficult. Different
companies may give different interpretations to the numerous adjustments noted above and
comparisons among companies doing business in multiple industries will add to the difficulty
of making valid comparisons.