Relative Total Shareholder Return Performance Awards

The following post comes to us from Frederic W. Cook & Co., Inc., and is based on the Executive Summary of a FW Cook publication by David Cole and Jin Fu. The complete publication is available here.

Since 2010, performance-contingent awards have been the most widely used long-term incentive (LTI) grant type among the Top 250 companies [1] and are now in use by 89% of the sample. The prevalence of performance awards and investor preferences have spurred considerable interest in relative total shareholder return (TSR) as a performance metric. Relative TSR measures a company’s shareholder returns [2] against an external comparator group and eliminates the need to set multi-year goals. Use of relative TSR performance awards among the Top 250 companies has increased from 29% in 2010 to 49% in 2014, and relative TSR is now the most prevalent measure used to evaluate company performance for performance awards.

The recent surge in relative TSR performance awards has been a topic of much discussion among the executive compensation community. Relative TSR plans are favored by proxy advisory firms, and proponents tout that such plans have strong shareholder alignment, are objective and transparent, permit multi-year measurement of performance, and do not require long-term goal setting. However, critics assert that relative TSR is not without its drawbacks. They highlight that TSR outcome is not entirely within management’s control as external factors often affect stock price and that TSR and financial performance are not always strongly correlated, particularly over shorter measurement periods. [3]

In light of the growing focus on relative TSR performance awards, the report (available here) explores current relative TSR award design practices in the market. Key findings are as follows:

  • Prevalence of relative TSR awards among the Top 250 companies has increased by 71% in the last five years (from
  • 29% of the Top 250 companies in 2010 to 49% in 2014). However, companies that grant relative TSR awards tend to diversify their performance measures, with 71% of companies using relative TSR in combination with another financial performance metric.
  •  Relative TSR is predominantly used as an independent metric in performance share plans (85%), with only 15% using relative TSR as an award modifier.
  •  When used as a modifier, relative TSR typically adjusts the final performance award payout by between 15%-25%, with the majority of companies using a ±25% modifier.
  • Eighty-eight percent of relative TSR awards use a component rank approach, with the most common threshold, target, and maximum goal levels set at the 25th percentile, 50th percentile, and 75th percentile of the comparator group, respectively.
  • Performance leverage among companies using a composite index varies, but target payouts are typically earned for achieving TSR that is aligned with the index performance.
  • A significant majority of relative TSR awards measure TSR over a three-year period (93%), with earned awards typically paid out at the end of the performance period (only 12% of plans have additional time-vesting restrictions). Among awards with multi-year performance periods, 93% measure TSR over the full performance period, 4% measure TSR in annual increments, and 3% use both an annual and cumulative measurement period.
  • Approximately half of the relative TSR awards measure performance against an existing stock index, while the other half are split between using the company’s compensation peer group or a custom relative TSR peer group. A few companies also use both an index and the compensation or custom peer group.

The complete publication is available here.

Endnotes:

[1] The Top 250 companies represent the largest U.S. companies in the Standard & Poor’s 500 Index by market capitalization.
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[2] Reflects stock price change plus assumed reinvested dividends.
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[3] As shown on page 11 of the complete publication, the correlation between TSR and financial performance is moderate in any given three-year period, but alignment between the two measures increases significantly over longer periods.
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