Relative TSR has become an extremely prevalent performance measure in long-term incentive plans and its use has continued to increase, even as companies, directors, investors and outside advisors question whether TSR is the best metric to use to incentive future behavior. A new report by Frederic W. Cook & Co. on practices of the top 250 companies in the S&P 500 explains TSR in simple terms, as well as the prevailing approaches these companies use to incorporate TSR into long-term incentives. The report shows that use of relative TSR has steadily increased in prevalence over the past five years, with 49% of the companies using it in 2014, a stunning 71% increase from 2010. Below are some additional highlights from the report:
- Modifier Less Common Than Metric. Relative TSR is almost always used as an independent metric (85%) rather than as a modifier (15%) in performance share plans.
- However, 71% of companies use TSR in conjunction with another performance measure to determine payouts.
- Comparator Groups. 88% of relative TSR awards rank the company's TSR against a comparator group (usually against the 25th, 50th and 75th percentiles).
- About half of awards use an existing stock index (the most common being the S&P 500) while 21% use the company's compensation peer group and 24% use a custom TSR peer group.
- Setting Targets. 93% of plans that use a percentile rank approach set target between the median and 60th percentile, with 84% setting threshold between 25th and 35th percentiles. All companies require performance at or above the 75th percentile for maximum payout.
- Payout Ranges. More than three-fourths (79%) of companies set threshold payout at between 25% and 50% of target, and a similar percentage (74%) set maximum payout at 200% of target.
- Performance Period. The vast majority (93%) of companies look at relative TSR over a three-year performance period.
- Design Practices. The report also noted that the majority of companies smooth stock price volatility by using a 30-day average stock price when calculating TSR. Growing trends include capping payouts if absolute TSR does not reach threshold limits (27% of companies).