HCC Industries transitioned from a stretch budgeting concept to a minimum performance standard (MPS) in 1986. Under stretch budgeting, division managers could earn bonuses for meeting 60% of budget targets. This led to consistent budget misses and lax performance. The MPS aimed to set budgets at a 100% probability of achievement but required exceeding normal capacity. However, managers were concerned about earning lower bonuses under the new system due to its vagueness. The report recommends quantifiably weighing performance goals to reduce subjectivity and increase transparency between corporate and employee incentives. This would help managers understand how to earn bonuses while meeting HCC's MPS goals.

1. Business 231: Managerial Accounting & Analysis
HCC Industries
William Duncan, Seth Stephen
Abstract
HCC Industries is a manufacturer of hermetically sealed electronic connection devices and microelectronic
packages. Until 1986, HCC operated with a stretch budgeting concept that was then altered to a minimal
performance standard (MPS). We recognize a major problem in the difference between company and employee
goals. In this report, we will analyze the decision to use MPS rather than the stretch budget concept, evaluate
employee expectations, and offer recommendations to better amalgamate corporate and employee goals.

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HCC Industries
Until 1986, HCC, a manufacturer of hermetically sealed electronic connection devices and
microelectronic packages, operated under the stretch budgeting concept, which considered the “belief that
aggressive targets would motivate the managers to perform at their highest possible levels” (Merchant,
329). This concept encouraged optimistic budgeting that in most cases, left divisional managers with low
chances of achieving budget goals. HCC had shown slow growth through this budgeting planning and
“the problem was that at 60% of budget, the managers were still in bonus territory, so they didn’t have to
worry much about meeting budget. Their budgets were like a wish. They were too easily blown off”
(Merchant, 332). Stretch targets encouraged optimistic budgeting that allowed more flexible management
performance, and therefore encouraged managers to disregard budget goals yet still receive 80% bonus
potential if profits before taxes met a threshold of 60% of their budget. As a result, divisions within HCC
consistently missed targets and managers adopted lax attitudes towards performance- they could still
receive a bonus despite a negative budget variance of 40%.
Before we enter a discussion about the transition to the minimum performance standard (MPS),
we must recognize the emergence of the firm’s major problem. HCC’s stretch budgeting concept had
potential to encourage managers to excel, but since the main goal of the managers was to earn bonuses,
the concept never fulfilled its potential. The goal of HCC and the goals of its managers and employees
differed in this sense. The reason why the stretch concept failed was this difference in goals.
When HCC transitioned into the minimum performance standard in 1986, the goal of corporate
was to set budgets so that “the felt probability of achievement was 100%” (Merchant, 323). To encourage
extra effort, “the managers were asked to set targets their reflected a performance level considered to be
beyond normal capability” that included a 25-30% increase in an area rather than 5-10% (Merchant, 323).
This change in budgeting concepts came with a change in incentive planning; “under the new plan, a
division bonus pool was created based on 20% of the amount by which actual division PBT exceeded the
MPS, plus 25% of the amount by which it exceeded the target” (Merchant, 333). The managers and
employees expressed a concern that they would not reach the same budget potential under the new
system. Under agency theory, employees are more concerned with short run performance related to their
bonuses than long run company performance. Combined with the fact that three of the four division
managers of HCC were engineers, who were “not very good at budgeting. They [were] engineers and
generally do not have a lot of business training,” meaning they had minimal future vision and a lack of
understanding of industry trends, both future and past (Merchant, 331). In an industry with such an

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emphasis on technology, an intense understanding of the industry is necessary. The nature of the industry
requires engineers to stay on the cutting edge of R&D to maintain competitive advantage, but also a
distinct ability to understand trends. Considering that no formal industry analysis takes place for HCC’s
budgeting, causing the company to be too reliant on their customers’ estimations on booking. This makes
HCC entirely too reliant on their customer’s performance and increases the impact of delinquency risk.
The fact that most managers lacked the necessary financial background to construct accurate budgets,
even though three of four preferred conservative budgets, presents a major problem in either budgeting
system.
The MPS system was beneficial in the fact that it solidified the goals of HCC corporate.
However, under the operation of the current divisional managers and employees who were still operating
under agency theory, the managers found problems in that “if they made only half their targets, they may
earn only 60% of the [bonus] pool” (Merchant, 333). Considering that all managers, with exception of
newly acquired Hermetite’s manager, Alan Wong - who happened to be the only manager with previous
MBA/CPA/Lawyer experience - preferred a conservative approach to budgeting, the MPS system should
have worked. However, when managers are operating under agency theory with an un-transparent
incentive system, even conservative managers can miss MPS budgets.
One of the managers’ main complaints was the incentive system of the MPS system. The
managers were required to set their budgets “so that the felt probability of achievement was 100%. In
addition to the MPS, the managers were asked to set targets that reflected a performance level considered
to be beyond normal capacity” (Merchant, 333). These performance targets were advised to involve a 25-
30% increase in something, a mark that would only have a roughly 50% chance of achievement. Under
the new incentive plan associated with the MPS, “a division bonus pool was created based on 20% of the
amount by which actual division PBT exceeded the MPS, plus 25% of the amount by which it exceeded
the target” (Merchant, 333). The main issue with this incentive plan continues to be the subjectivity of the
plan; the details of the plan were left “vague because the importance of particular targets varies over time”
(Merchant, 333). HCC’s COO, Al Berger “did not want to quantify the relationships” between the bonus
pool and the seven performance areas (1. PBT, 2. Bookings, 3. Returns (as percentage of total dollars
shipped), 5. Rework aging (number of jobs and percentage less than 30 days), 6. Efficiency (net
sales/number of employees), 7. Delinquencies (dollar volume and percentage of delinquent orders
outstanding). The mistake here is that there is little transparency between corporate and its employees.

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To resolve this issue, we recommend that the COO sit with each divisional manager before each
fiscal year to determine and weigh the importance of each performance area. By weighing the importance,
HCC reduces subjectivity, which, in turn, reduces the need for a long approval process and allows for a
quicker, more efficient bonus turnaround. It also combines the MPS system that corporate desires with the
transparency that the managers want. By quantifiably weighing the importance of each performance goal,
HCC can set standards that will keep it in business long term while adhering to the managers’ desires to
earn bonuses. Because the managers will understand exactly which performance area is weighted how,
they will understand which areas they need to perform well in to earn a sufficient bonus. In our
recommended bonus incentive plan, the managers will earn their desired bonuses and HCC corporate will
achieve their MPS goals.
In the appendix, we have included a sample budget calculation for the year 1988 from here on
out. Through reducing subjectivity and increasing transparency, the individual divisions will be able to
know exactly what they need to accomplish to earn their bonus and corporate can help set budget goals
that are beneficial and attainable.

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Appendix

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