Finance 405
After receiving a telex from the Controller of the Irish plant, who is an integral employee at Universal Circuits, we had to make a tough decision regarding his request to hedge against the US dollar depreciating. If the US dollar depreciates, manufacturing would be shifted from his Irish plant to the US plants, which in turn would negatively affect his potential bonus.
We acknowledge this risk, which would be incurred to him, but also cannot afford for him to hedge against the company’s interest as a whole. The company uses the Irish plant itself as Universal’s hedge against foreign exchange risk, shifting manufacturing accordingly in order to take advantage of the lower cost of production. What we decided on was to strike a balance between putting the exchange rate risk on our employees and our shareholders.
We plan to continue to follow Mr. Kriesler strategy of selective hedging, while incorporating Pierre Bourquin’s idea of dynamic strategy to reduce our economic exposure. In order to keep the Irish plant controller’s exposure to exchange rate risk at a minimum, we would like to implement a monthly valuation process to respond to a fluctuation of company sales and exchange rates.
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What we are aiming to do is to guarantee the Irish plant controller a small bonus if the Punt appreciates against the dollar and the manufacturing is shifted from Irish to US plants. We want to put a limited hedge on his exchange rate risk he faces, as his bonus is tied to the Irish plant’s manufacturing performance. But, we do not want to fully hedge, and reverse our company’s original hedge using the Irish plant for manufacturing. Based on our equation in appendix #1, the bonus will fluctuate (on a monthly basis) as dependent on the change in exchange rates and change in monthly sales.
The greater the fluctuation in exchange rates, the larger the bonus will amount to. The same goes for the variable side of the bonus in terms of an increase in monthly sales from the previous year average. If the exchange rates remain constant and monthly sales do not increase, there will be a bottom fixed payment for the minimum monthly bonus. From a general standpoint, we are taking the previous year’s sales and converting into a monthly sales basis to give a proper valuation method for the fixed portion of the bonus. We are also using the max and min functions to appropriately compensate and comply with the company hedge already in place based on fluctuations in exchange rates.
The obvious upside to the new compensation is that the controller will be kept happy and given an incentive to work harder.
The biggest downside to our strategy is that the new compensation structure will inevitably cost the company more money. In addition, Universal Circuits views the Irish plant as a hedging strategy against foreign exchange fluctuations, therefore this small hedge is counterintuitive to the company because it reveres a portion of the hedge of the Irish Plant.
For our purposes we want to be cost effective and sympathetic in terms of the bonus system in place for the controller. Another con of the new compensation structure is employee sentiment. Employees in the Irish plant my see this as a sign of not being appreciated and this could subsequently affect their overall productivity.
The main benefit to this plan is it allows the controller of the Irish Plant to be hedged against a depreciation of the U.S Dollar. This allows the company to retain his skill and experience through protecting his job; as the U.S. Dollar depreciates, production shifts to the United States, limiting the output of the Irish Plant.
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