February 8, 2016
As a result of increased scrutiny on pay for performance by investors and regulators, more companies have incorporated total shareholder return (TSR) in their incentive plans. Equilar’s latest Equity Trends Report shows that almost 50% of S&P 1500 companies use TSR as a metric for performance equity—by far the most prevalent metric. In most cases, TSR is measured on a relative basis to a specific peer group or an index. Although TSR is considered to be shareholder-friendly and viewed favorably by proxy advisory firms, companies often argue that it does not accurately measure performance since it can be influenced by economic factors outside the control of the organization.
As companies work to establish well-designed programs that include TSR, alternative arrangements including TSR modifiers have evolved. A TSR modifier is used as a secondary metric (the primary is an internal performance metric) to limit or augment award payouts given specific TSR thresholds. In a recent study, Equilar looked at 25 S&P 500 companies that use relative TSR (rTSR) to modify financial or operational metrics in their long-term incentive plans.
Three main modifier types were captured in the study. The majority of companies in the sample (84%) opted for a multiplier modifier, which provides adjustments multiplied by the earned amount. For example, a 30% payout with a +20% modifier would result in a 36% payout. Less common modifiers in the sample include additive and capped payment plans. Two companies in the sample—or 8%—used the additive modifier, which serves to add or subtract percentage points to the earned amount (30% payout with a +20% modifier would result in a 50% payout). The remaining two companies elected to cap payment. For example, a 200% payout earned by weighted metrics would be reduced to 100% if a modifier cap of 100% were triggered by failure to achieve a threshold level of rTSR. Interestingly, most of the companies in the sample (64%) chose the S&P 500 as the comparator group rather than a narrower peer group selection.
The goal of any incentive plan is to stimulate high performance, drive company growth, and ultimately, build long-term shareholder value. Companies are employing these various TSR modifiers in their incentive plans to satisfy shareholder expectations, but also to shape plans around absolute financial and operational goals that provide top executives with line of sight payout opportunities.
For more information on Equilar’s research and data analysis, please contact Dan Marcec, Director of Content & Marketing Communications at firstname.lastname@example.org.