TSR Tracking – Inclusions and Exclusions

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Last month we outlined the effect of smoothing on tracking total shareholder return (TSR) for the assessment and verification of employee entitlements.

This month we look at the issue of inclusion or exclusion of delisted companies from an agreed peer group in determining vesting entitlements.

Given the stock market’s dynamic nature, it’s fairly certain that not all companies in the peer group will still be listed at the end of the performance period.

If these companies are included in the end result, it may provide a different result then if the companies are removed from the index to make a smaller comparator group.

To see the difference this decision can make, we examine the same two companies we analysed last month, A and B. Let us again assume they both have a vesting profile where 50% of their equity vests at the median of the peer group (in this case we’ve chosen the ASX300) and 100% at the 75th percentile. We will use 60-day smoothing.

Company A’s performance compared to the performance of the peer group can be seen in the graphs below, the first including delisted companies and the second excluding them. (Company A is depicted in red. TSR is rebased to 100 at the beginning of the period.)

TSR Performance Company A Excluding Delisted Companies
TSR Performance Company A Including Delisted Companies

As can be seen in the graphs, the sample company remains above the 75th percentile of the peer group at the end of the performance period however we treat delisted companies (and hence the same amount of equity will vest to executives).

This is not the case for Company B, also depicted as a red line in the graphs below:

TSR Performance Company B Including Delisted Companies
TSR Performance Company B Excluding Delisted Companies

As can be seen, there is again a large difference in final ranking between the two scenarios – company B falls below the median if delisted companies are excluded, but above the median if they are not.

For the given vesting schedule, choosing one scenario over the other will be the difference between equity vesting and no equity vesting.

Any inclusions or exclusions from an index comparator group may affect vesting in a similar fashion, whether the changes are to customise the peer group for better alignment with the sample company or to take into account companies moving in or out of the index, demerging, or divesting significant assets and businesses.

It is imperative that companies consider the composition of peer groups carefully and remain consistent in their methodology.

Egan Associates’ analytics function supports clients in this area, providing advice on what is most appropriate for the organisation.

We provide a benchmark analysis service for relative TSR to determine the percentage of rights/options which vest and verify Board and/or Remuneration Committee decisions to vest securities. We also monitor relative TSR performance over a series of grants on a quarterly or six monthly basis as requested by clients to inform the Board, Remuneration Committee and key executives how performance is tracking against TSR hurdles.

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