Learn about the pros and cons of using Total Shareholder Return (TSR) in a compensation plan and what other measures may be more effective, either in place of or in tandem with TSR.
Q. What are the pros and cons of using Total Shareholder Return (TSR) in a compensation plan?
A: In compensation committee meetings, we often talk about whether or not TSR is an effective metric for an incentive program. We know TSR helps align executive and shareholder interests, and proxy advisors and the SEC are looking at TSR in order to evaluate company performance, even in the one-year timeframe. So there are clear reasons why many use it. And if we could measure TSR over a ten-year period, that would almost certainly give a good indication of performance. However, most plans look at three years and in that time, there’s generally a lag or a lead between TSR and operational performance, so there is a potential for mismatch. Additionally, when TSR is used as an incentive, there’s no real indication to an executive team how they can influence performance that leads to strong TSR. There are a lot of external pressures to use TSR, but its inclusion shouldn’t be an automatic decision. In fact, we have new research showing its use as an incentive measure does not lead to improved company performance.
Q. Are there other measures you find to be more effective, either in place of or in tandem with TSR?
Again, we find TSR as an alignment tool is quite effective, particularly over an extended timeframe. But when it comes to incentive metrics, there is no one-size-fits-all approach. It’s critical for companies to know what metrics correlate with strong TSR performance, how goals should be set under these metrics, that senior leadership teams have a clear understanding of the actions needed to attain these goals, and that this approach carefully aligns to the company’s unique business environment and strategy.
