TSR: The Evolution of a Popular Metric


The selection of Total Shareholder Return relative to a group of competitors or an index is often viewed as an easy choice for a long term incentive (LTI) performance hurdle. It is simple to track, removes the need to set absolute goals annually, and is easy to explain to shareholders. It also provides a yardstick with which to measure how well the company is performing for shareholders in comparison to other companies, taking the rise or fall of the market out of the equation. This has led to a preference to its use by proxy advisors. ISS Group states:

“Generally, a hurdle that relates to total shareholder return (TSR) is preferable to a hurdle that specifies an absolute share price target or an accounting measure of performance (such as earnings per share: EPS) … Where an absolute share-price target is used, executives can be rewarded by a rising market even if their company does relatively poorly. In addition, even if a share-price hurdle is set at a significantly higher level than the prevailing share price, then the hurdle may not be particularly stretching if the option has a long life and there are generous retesting provisions.”

However, companies using relative Total Shareholder Return as their only performance measure run the risk of rewarding executives when the real return to shareholders is minimal or negative because the market as a whole has gone down (especially an issue if the peer group is too small or has been selectively chosen to put the company’s performance in a positive light). There have also been concerns raised that TSR is too reliant on factors outside of the executives’ control and is not driving their commitment.

Egan Associates does not believe that executives should be rewarded when they have not enhanced shareholder value. Therefore, long term incentive plans must be carefully designed using measures that will both motivate executives and create shareholder wealth.

One way of hindering a payout when a company has performed poorly, but better than its peers, is to modify a relative TSR hurdle with a gateway or make part of the at-risk pay contingent on a separate hurdle. Indeed, Egan Associates analysis has shown that while relative TSR is by far the most popular hurdle used by Australia’s Top 100 companies, the percentage of those companies using relative TSR as a sole measure has dropped over the last four years and the dual hurdle construct has increased markedly.

A popular second measure is absolute earnings per share (EPS), which has experienced increasing use over the last four years, both alone and together with relative TSR.

There has also been some discussion in recent times about using risk-adjusted measures in conjunction with TSR to adjust for the risk and volatility of a stock, reflecting the appetite post-GFC for consistently performing investments. Stock beta – the sensitivity of the company’s share price movements to the market as a whole – features in most of these considerations.

As mentioned in our May Newsletter, there are limitations around using a company-specific beta to measure risk, since beta is measured on the basis of historical returns and assumes these returns will repeat in the future. In addition, our recent analyses have not shown a significant difference between using relative TSR adjusted for stock beta and relative TSR on its own, and in our experience, adjusting for risk does not necessary contribute to a better aligned LTI plan. Far more important to the success of a relative TSR measure is the selection of an appropriate peer group, which requires an understanding of the company’s milieu.

At Egan Associates, we draw on decades of experience in selecting appropriate peer groups and performance hurdles for effective executive long term incentive plans that foster shareholder wealth creation.

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