by Cydney Posner

While TSR (total shareholder return) is increasingly used a performance metric for executive compensation, a study by Cornell University and Pearl Meyer, an executive compensation consultant, showed no real correlation to improvements in company performance, reports the WSJ.   In the study, over 48% of S&P 500 companies used TSR as performance metric in 2013, up from less than 17% in 2004. However, according to one of the study’s co-authors, “[t]here was not any conclusive evidence that the positive relationship was there.”

Although more companies rely on TSR, the proportion of compensation tied to TSR has decreased: “the metric determined about 35% of the compensation package among the top five company executives in 2013, down from nearly 47% among the smaller pool a decade earlier.”

This study is not alone in reaching the conclusion that TSR may not always be the best metric.  As discussed in this PubCo post, a report by Organizational Capital Partners and the Investor Responsibility Research Center Institute contends that most companies are using the wrong metrics to align executive pay with performance.  Rather than using metrics related to creating sustainable, long-term value, the report maintains, companies are tying compensation to short-term market returns – a practice characterized as the “tyranny of TSR.” That report, which studied companies in the S&P 1500, asserted that the “best measure of economic value creation is economic profit, i.e. net operating profit minus a capital charge for invested capital.  Moreover, the report maintains, tying compensation to share price appreciation through TSR is deeply misguided because factors that affect share price, such as “fund flows, central bank policies, macroeconomics, geo-political risks and regulatory changes are all beyond the control of executive management.”

According to a representative of Pearl Meyer, although “’TSR is a wonderful tool to understand the long-term effectiveness of linking pay and performance,’ it is not particularly helpful in short-term compensation decisions. Many firms, for instance, use three-year-TSR performance, but it’s common for three-year TSR to often be a lagging or leading indicator of future performance. That can lead to low pay before strong performance and elevated pay before business heads south.” The proliferation of TSR as a compensation metric can also lead companies to overlook other criteria, such as return on invested capital. The representative advises that “'[t]here is no magic metric’”; the best metric for one company may not work well for another.  The article suggests that boards need  to do their “homework” to best identify “which measures are indicative of the best performance of a company, relative both to its peers and the broader market.”



Posted by Cydney Posner