Prior to being acquired by Amazon.com, Whole Foods Market provided that its Compensation Committee would determine a portion of executive bonuses by selecting from a list of 13 performance metrics. For the fiscal year 2014, the Compensation Committee selected the following five quantitative performance criteria:

1. Comparable store sales growth
2. Year-over-year improvement in EBITANCE
3. ROIC
4. Year-over-year improvement in EVA®
5. Positive free cash flow
Comparable store sales growth represented growth in sales from stores open for the entirety of the current period and the comparison period. EBITANCE was earnings before interest, taxes, and noncash expense. Noncash expense included depreciation, amortization, fixed-asset impairment charges, noncash share-based payment expense, deferred rent, and last-in, first-out (LIFO) charge. ROIC was net income divided by average invested capital. EVA® was economic value added, which is described in this chapter. Positive free cash flow is cash flow from operations minus capital expenditures.

Whole Foods did not use stock price performance as a factor in determining annual cash compensation. However, the company believed a relationship existed between stock price and team members’ performance, so that its compensation plan was designed to reward team members for positive stock price performance.

Required:

1. Compared to GAAP earnings, what advantage does EVA® provide as a performance metric for incentive compensation purposes? Why might this advantage be particularly important for companies such as Whole Foods Market?

2. Explain why Whole Foods Market did not use stock price performance to determine annual compensation for its executives. What mechanisms other than annual compensation might the company use to encourage managers to create shareholder value?

3. What impact (if any) does EVA® use have on earnings management? In other words, will managers be more likely or less likely to use accounting tricks to achieve EVA® bonus targets than is the case for traditional GAAP earnings targets?

4. Explain how the EVA® pool works and why it might help overcome management’s tendency to focus on the short term.

5. How does using a weighted average of five performance metrics alter an executive’s behavior relative to if he or she faced a single performance metric?