Relative total shareholder return performance award report by Frederic W. Cook & Co., Inc.
Relative Total Shareholder Return Performance Award – Executive Summary
Since 2010, performance-contingent awards have been the most widely used long-term incentive (LTI) grant type among the Top 250 companies1 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 total shareholder return measures a company’s shareholder returns2 against an external comparator group and eliminates the need to set multi-year goals. Use of relative total shareholder return performance awards among the Top 250 companies has increased from 29% in 2010 to 49% in 2014, and relative total shareholder return is now the most prevalent measure used to evaluate company performance for performance awards.
The recent surge in relative total shareholder return 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 total shareholder return 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 total shareholder return and financial performance are not always strongly correlated, particularly over shorter measurement periods.
In light of the growing focus on relative total shareholder return performance awards, this report explores current relative TSR award design practices in the market. Key findings are as follows:
- Prevalence of relative total shareholder return 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 total shareholder return 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 total shareholder return over the full performance period, 4% measure total shareholder return in annual increments, and 3% use both an annual and cumulative measurement period.
- Approximately half of the relative total shareholder return 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.
Relative Total Shareholder Return – Overview and Background
This report presents information on relative total shareholder return award design practices currently in use for executives of the 250 largest U.S. companies in the Standard & Poor’s 500 Index (Top 250 companies) as of mid-2014. These companies are selected annually based on market capitalization, i.e., share price multiplied by total common shares outstanding as of February 28, 2014, as reported by Standard & Poor’s Research Insight (see Appendix for complete list of companies). All information was obtained from public documents filed with the Securities and Exchange Commission (SEC), including proxy statements and 8-K filings.
Relative Total Shareholder Return – Methodology
Relative total shareholder return awards are considered to be in use at a company if such grants have been made in the current year or prior year and there is no evidence that the grant practice has been discontinued, or if the company indicates that the grant type will be used prospectively. Findings in this report do not differentiate between LTI awards that are denominated in cash, shares, or share units.
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