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Relative TSR: The Downsides

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February 13, 2018 | Barbara Baksa

Relative TSR: The Downsides

According to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey, the usage of TSR awards has grown dramatically in the past decade and TSR may have surpassed EPS in popularity as a performance metric (see “Data Snapshot” in the March-April 2017 issue of The NASPP Advisor). But is there a downside to relative TSR awards?

An article at provides an interesting perspective on relative TSR awards (“A Theory of Relativity Misses the Mark” by Gregory Milano). Milano studied Russell 1000 companies and found that the relative TSR metric does not always have the effect of linking pay to performance. For the companies in the study, he compared what payouts would have been for a typical TSR award for 10 three-year cycles (the typical performance period) versus what the payout would have been if payouts had been tied to cumulative TSR performance over the full period from 2004 to 2016. He found that the payouts for the typical three-year cycles would have over- or underpaid executives by an average of 45% based on the cumulative performance for the overall period.

Sometimes, just the start date in the performance cycle can greatly affect TSR performance and ranking. Milano analyzed relative TSR usage by 850 of the Russell 1000 companies from the start of 2013 through the end of 2016. The study calculated the relative TSR percentile ranking by company during 53 three-year cycles ending as of each week in 2016. A comparison of TSR against the company’s sector found that the payout varied from 0% to 200% for one in thirteen companies, depending on which week the performance test was measured. The average difference from minimum to maximum vesting was 88%.

Milano suggests that TSR awards amount to a “lottery ticket” and recommends awards tied to operational metrics instead:

The good news is that there’s a better approach. We have found that companies are better off implementing performance tests based on operating performance. For example, a grid that’s based on revenue growth and either improvement in return on capital, improvement in operating profit margin, or improvement in residual cash earnings (a cash flow based measure of economic profit) can be designed so that PSU vesting relates well to TSR among peer companies and, at the same time, gives management a definitive path on how to drive long-term TSR success through tangible operational goals.

In her Cooley PubCo blog, Cydney Posner discusses this study and briefly covers others in a sidebar that criticizes the use of TSR and recommends other metrics instead (“Do Performance Metrics Based on rTSR Transform an Equity Award Into a Lottery Ticket?”). Posner observes that “companies may well have been taking note of these issues.” She finds that support for the use of relative TSR has flattened out as a performance metric for CEO pay at S&P 500 companies.

- Barbara

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