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Long-term incentives are the largest component of a typical executive compensation package, and by mid-2013, total shareholder return (TSR) was the most prevalent performance metric for long-term incentives at the 250 largest U.S. companies. However, when reviewing the structure of long-term incentive plans for senior executives, both business cycle and the manner in which a selected peer group company makes its money are also important considerations.
“Absolute goals are still far more common, but relative goals are gaining in popularity,” said Peter Lupo, managing director at pay consultants Pearl Meyer & Partners. But the review shouldn’t end there,Lupo said. Companies also need to review their competitors. Historically, compensation committees have looked at companies similar in size based on revenue. But Lupo said two other criteria are more important: business model and cycle.
Business cycle is particularly important for a company whose cycle involves peaks and valleys. If it peaks when companies in its peer group are in valleys, then its performance comparisons would be skewed. A company also wants to make sure the firms in its peer group make money the same way as it does, otherwise they could perform differently.