BUS444 Advanced Management Accounting
Woodhaven Service: Case Study
BUS444: Advanced Management Accounting
A. The case presents two approaches to alleviating agency costs: Dr. Weisbrotten’s approach and Harold Mateen’s idea of hiring “harder-working” mechanics. Although these methods have aspects that are consistent with the information presented in the text, neither of these methods are likely to succeed. Some of the similarities and differences between the chapter and this case for each approach include the following:
- Weisbrotten’s approach to improving productivity is to educate individuals on their rights and responsibilities as an employee; however, this contradicts with the text. More specifically, the text states that agents act in their self interest to maximize their utility and in this case Harold is trying to alter the preferences of his employees. After spending an hour each day for two months, Harold soon realized it didn’t work – this is because self-interested individual’s preferences are difficult to change. To improve productivity and reduce goal incongruence, Harold should implement incentives that when employees (agents) maximize their utility his utility as the employer (principle) is also maximized. After Dr. Weisbrotten’s approach didn’t work, Harold figured he would have to hire harder working mechanics.
- Harold Mateen’s approach of hiring “harder working” mechanics to increase productivity would reduce the gap between the agent and principle’s goal; however, the idea of finding harder working people is insensible.
B. Harold believes the low profitability in repair services at Woodhaven is due to the lack of productivity of this mechanics; however, he believes with a new incentive compensation plan he can become the most successful service station in the area. After consulting with a fellow shop owner, Harold has two incentive plan options: straight commission and a flat rate with a commission rate. Under the new compensation proposals, Harold may experience other undesirable behaviours then low productivity. More specifically, as mechanics are being paid a percentage of sales Harold may see deceitful revenue being generated. For example, mechanics might start doing major work, that they may or may not be qualified to perform, that costs substantially more then the current automotive maintenance Woodhaven provides. Further, the quality of work may decline as mechanics may be inclined to work faster to fit in more jobs in their shift. These divergent behaviours would negatively impact the image of Woodhaven Service and could lead to the business being unsuccessful. The following propositions: flat rate with commission and an upper bound on earnings are both realistic options.
- Harold’s plan to offer a flat rate of $300 with the ability to earn commission offers less incentive for divergent behaviour then honest Jack’s straight commission. With a base pay, Harold can expect less unnecessary work to be charged to customers then Honest Jack’s proposition as employees will still be able to meet their financial obligations without cheating customers.
- By limiting a mechanic’s pay by placing an upper bound of $750 per week the employee will have a limited incentive to cheat the customer. More specifically, the mechanic may feel guilty or have a fear of getting caught which would likely result in pay below $750; however, if you ignore these feelings, at some point it would no longer be profitable for the mechanic to cheat the customer. The upper bound limit of $750 would either reduce the incentive or cause no change.
C. If Harold owned a large auto repair franchise in a popular suburban shopping mall that was heavily promoted, well-known, and known for it’s good values and easy credit Harold’s thoughts on incentive compensation may change. In his current position, if Harold provided an incentive compensation plan that encouraged mechanics to cheat customers by over charging, completing unnecessary work, or providing low quality work – word would travel fast and the likelihood of his business being successful for a long time to come would be unlikely. Therefore, Woodhaven Service has a high cost of cheating; however, if Harold owned the large auto repair shop the cost of cheating would be less. Due to the location, easy credit, and the ability to attract new customers through promotion the chance of the businesses failing is low and either incentive plan would likely be implemented. If Harold was a manager not an owner, his thinking on changing the incentive compensation is unknown. Depending on how Harold’s pay is determined, incentive compensation for the mechanics may be favourable if Harold’s performance is based on the amount of sales or irrelevant if he receives a salary.
D. In the case of Woodhaven Service, the mechanic can decide what services are warranted and perform them; therefore, he or she has an increased ability to cheat the customer. If you took this right away by having a supervisor approving work to be performed, the employee would have no reason to cheat the customer; however, the cost of having an onsite supervisor could be greater depending on the size of the shop. Woodhaven service is a small shop which performs automotive maintenance. This means there is minimal work to supervise and with 20 years experience Harold has the knowledge to know what services and required; therefore, the cost of control is low. If Harold owned a chair-store repair shop in a mall, the amount of work to be supervised would be too substantial for Harold to approve on his own and he may not have the knowledge to understand what work is required for extensive repairs. This means the cost of control would be high. Therefore, having knowledge and decision rights linked makes more sense at the chain-store repair shop then at Woodhaven Service.
E. If Woodhaven’s problems are not due to agency costs, a likely problem is the capacity of the shop and/or the low prices. More specifically, the background states that “the station has three gasoline pumps and two service bays” and offers maintenance and minor repairs but refers customers with major repairs to more equipped shops. Lastly, Harold states that demand for his services is more then he can meet. Customers are loyal to Harold and purchase fuel from him; however, he could expand his repair services and/or increase prices so supply would equal demand.
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