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Compensation committees that are considering adding total shareholder return as a performance metric in incentive programs are being warned to tread lightly and not succumb to pressure, experts say. Use of the metric has skyrocketed, experts say, mainly because proxy advisory firms favor the measure due to its alignment with shareholder return. However, compensation committee members say the use of TSR is not right for every company.
Research by Cornell University ILR School’s Institute for Compensation Studies, in collaboration with consultancy Pearl Meyer, found that in 2013, 48.3% of the S&P 500 used the metric, compared with roughly 16% in 2004.
According to a survey by Pearl Meyer, 75% of respondents said that they included TSR because of peer practices, 56% said it was included in response to investor concerns and 52% said it was in response to a proxy advisory group.
Aalap Shah, Managing Director at Pearl Meyer, said this is a worrying trend because following what others do does not necessarily lead to creating a meaningful executive compensation program. He pointed to the Cornell and Pearl Meyer research, which found that while more companies are adopting TSR as an incentive metric, those that have brought it into their plans more recently are putting less weight on it.
“What this indicates is that companies don’t think it is the right thing to do, or are not sure if it is the right thing to do,” said Shah. “So what happens is that you are missing an opportunity to place a greater emphasis on a meaningful existing metric that has a potentially demonstrated correlation to value creation or adding other metrics that have that ability to add value over the … performance period.”
Shah said that once companies add TSR to an incentive program, it is hard to change it, or take it out. “You could get pressure in subsequent years if you decreased the weighting or removed the metric,” he added.
“If you currently don’t have total shareholder return in your program and are thinking about it, this is one of those things that you cut once, measure twice,” Shah said. “You will certainly be talking about it; hopefully you will decide it is best for the company and not do it because everyone else is.”