Franz Manteca is the president of Gillespie Storage, a wholly owned subsidiary of Vanguard Industries. His annual salary is $600,000. In addition, he receives a $200,000 bonus if Gillespie Storage’s profit exceeds 75 percent of budget. He also receives 1 percent of any profit over 75 percent of budget. His total bonus is capped when Gillespie Storage’s profit exceeds 120 percent of budget.

Required

a. Each year, Franz spends hours negotiating the profit budget for Gillespie Storage with the senior management team of Vanguard Industries. Invariably he claims that their sales estimates are too high and their cost estimates are too low. They in turn claim that Franz is padding his budget. In this context, what is meant by budget padding? Explain why Franz may indeed have an incentive to pad his budget. Provide an example of how budget padding may hurt company performance.

b. For the current year, the profit budget was set at $50,000,000.Late in the fourth quarter of the current year, Franz received a report from Gillespie Storage’s CFO indicating that actual profit would be close to $65,000,000.Franz then ordered that planned shipments for the last two weeks of the quarter be delayed until the start of the next year. Why did Franz take this step? What is the effect of this action on shareholder value?