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Executive compensation is increasingly pegged to shareholder returns as corporate boards look to align pay packages with business success. Problem is; there’s little to indicate company performance improves as a result.
More than 48% of S&P 500 companies tied compensation to total shareholder return – stock performance plus reinvested dividends – in 2013, according to a study by Cornell University and Pearl Meyer, an executive-compensation consultant. That’s up from less than 17% in 2004.
The proliferation of TSR as a compensation metric is likely tied to governance advisors, according to Peter Lupo, a Managing Director with Pearl Meyer. Those advisors typically evaluate pay packages based on TSR, which overlooks other criteria like return on invested capital.
While “TSR is a wonderful tool to understand the long-term effectiveness of linking pay and performance,” Mr. Lupo said, it is not particularly helpful in short-term compensation decisions. Many firms, for instance, use three-year-TSR performance, but it’s common for three-year TSR to often be a lagging or leading indicator of future performance.
“There is no magic metric,” to appropriate compensation practices, as it varies widely between companies and industries, Mr. Lupo said. To determine the best benchmarks, Lupo told boards and investors “to do your homework” in order to know which measures are indicative of the best performance of a company, relative both to its peers and the broader market.