As companies and investors continue to refine their use and understanding of how performance metrics drive and align with shareholder return, many issuers are taking a creative approach to including total shareholder return (TSR) in their plan design, according to a recent Equilar study.
Although in 2015 a full 57% of S&P 500 companies linked CEO pay to TSR in some way, between 2014 and 2015 use of TSR plateaued, with no further rapid growth along the lines of what we saw from 2010-2015. Looking at 2014 and 2015 LTI plans for the S&P 100, Equilar found that nearly a fifth (18%) of companies used a TSR modifier in their long-term plans. In many cases this was used in conjunction with TSR as a weighted metric - for example, use of an absolute TSR gate -- for example the requirement that the company register positive TSR -- to prevent relative TSR plans from paying out if shareholders lost money. However, other metrics such as return on capital, revenue, cash flow and EPS were also subjected to TSR modifiers.
Equilar's findings support an overall shift in how companies think about TSR with regard to incentive plan design as companies "have begun to question its ability to incentivize CEO behavior and performance." A 2016 study by Willis Towers Watson of the S&P 500 found that between 2011 and 2015, the percentage of companies using TSR as a modifier rose from 14% to 19%, and further noted that 82% of companies using TSR as a modifier did not use TSR as a weighted metric in their plans; rather, the use of TSR as a modifier was a way to incorporate shareholder return into incentive plan design while still retaining the financial or operational metrics that drove company performance and were within the line of sight of executives.
With the focus on metric selection and target setting continuing to intensify, companies may benefit from considering creative ways to connect incentive plan design to long-term shareholder value while maximizing pay for performance alignment.
Meanwhile, writing in her New York Times column, this week, Gretchen Morgenson noted the use of TSR in CEO pay plans, noting the combination of the use of TSR in pay plans and the increase in stock prices generally after the November election "the Trump effect on CEO pay." However, in using examples from the paper's annual pay survey (see story above), many of the nuances of long-term incentive plans are glossed over due to use of Summary Compensation Table pay numbers with little attention to the performance requirements that will yield compensation at the end of the performance period.