Case Study

How an Energy Company Tracks Value Changes in TSR Awards

Monte Carlo Simulator

The Compensation Team at Energy Co., a publicly traded energy organization, has put in place an executive incentive plan to align the interests of its top executives with the Company’s long-term performance and to drive shareholder value creation. To achieve this goal, the Company has elected to incorporate Total Shareholder Return (TSR) awards into its executive compensation structure. TSR awards tie executive compensation directly to the Company's stock performance relative to its peers in the market.

Challenge

Determining the fair and effective valuation of TSR awards is crucial for ensuring that executives are appropriately rewarded for contributing to the company's success. However, TSR is subject to market fluctuations, making it challenging to predict future stock performance accurately. Furthermore, the Securities and Exchange Commission (SEC) passed Pay Versus Performance rules in August 2022 that require companies to disclose Compensation Actually Paid (CAP) values for its principal executive officers (PEOs) to capture changes in award values. To address these challenges, Energy Co. chooses to leverage the Equilar Monte Carlo Simulator, developed in partnership with Equity Methods, for TSR award valuation.

Solution

The Compensation Team would like to determine the value of a TSR award on March 1, 2022 with a performance period between January 1, 2022 to December 31, 2024. The Company begins by entering a few data inputs into the Monte Carlo Simulator, including the Company’s peer group, the award’s performance period and payout schedule features.

Combining Equilar’s industry-leading compensation solutions with Equity Methods’ state-of-the-art modeling capabilities, within seconds, the Monte Carlo Simulator runs over 100,000 simulations of potential outcomes of stock price through the duration of the award and provides a Monte Carlo value based on the parameters the team inputted into the platform. The tool also provides information related to the Total Shareholder Return for both the distribution of the peer group as well as for Energy Co., and its current ranking within the peer group. The Compensation Team may run an unlimited number of experiments to analyze the impacts of various incentive plan features.

Results

By leveraging the Monte Carlo Simulator for TSR award valuation, Energy Co. can implement a robust executive incentive plan that aligns executive interests with long-term shareholder value creation while considering the inherent unpredictability of the stock market. The Compensation Team may use the tool to work across multiple departments, including Human Resources, Finance and Legal, in support of their CAP calculations within the Pay Versus Performance proxy disclosure. Overall, the Company is empowered by the Monte Carlo Simulator to stay ahead of the overall value change of executive awards year over year, allowing it to provide pro forma analyses and updates to the Board as TSR award values fluctuate over time. The use of this sophisticated simulation tool enhances transparency and fosters trust between executives, the Compensation Committee and Energy Co.’s shareholders.