Say on Pay

Are Relative Total Shareholder Return (TSR) Plans “The Answer”?

Posted by Paul McConnell on May 06, 2013  /   Posted in Compensation Committees

[Originally published in Board Member Magazine 2013 Q1.]

stockThere has been a great deal of recent interest in performance share plans that use Total Shareholder Return (TSR) relative to a peer group as a measure of performance.  Clearly, these plans usually look good in a pay for performance comparison and can help secure favorable say-on-pay votes, but the additional questions Compensation Committees should be asking are:

  • Do they motivate executive performance?
  • Are they right for this particular company?
  • Does TSR reflect true executive performance?
  • Is this the only performance-linked program we should use?

Any discussion of total shareholder return must start with the understanding that TSR is a result of good management performance, not the performance itself.  The desired management performance is the production of great products/services, properly priced for consumer value, that deliver consistent financial returns commensurate with the riskiness of the required investment.  If the market sees this performance, share prices are bid up relative to peer companies and positive relative TSR results, assuming of course, other, exogenous events do not occur.

From a motivational perspective, the strongest incentives are those where a clear line of sight exists between the desired behaviors (performance) and the reward.  TSR plans may not provide as clear a linkage as plans tied to measures of operating performance.  Even though it may be very hard to do, executives know what it takes to raise net income by 10%; it is less clear what it takes to raise the stock price by 10%.  And the market is not necessarily rational, certainly not in the short term but also seemingly for the long term as well.  Thus plans tied to operating metrics more clearly convey performance expectations and behaviors.  However, executive pay is not just about incentives and motivation.  It’s also about sharing the risk and reward of ownership.  What then are the situations where risk sharing is more important than communicating performance expectations?  Although the following list is not exhaustive, it shows the areas where we think these plans have value.

Shareholder Relations Issues:  In cases where there have been historical issues with the pay for performance relationships, relative TSR plans alleviate that problem – in fact, better than outright share ownership.  By definition, the change in the value of executive shares owned has a 1 for 1 alignment with TSR.  TSR performance plans have a more exaggerated relationship, due to the fact that the value of the shares awarded as well as the number of shares themselves vary with TSR.  The value of these shares typically climbs faster and drops more quickly than total shareholder return itself does.

Change in Strategy/Turnarounds:  In these situations, it is difficult to set reasonable performance goals.  Success will likely be much different than current expectations.  But a successful turnaround will likely have a dramatic impact on TSR, as the market builds new expectations into the market price.  These kinds of awards are also useful in justifying the kind of above market grants that are typically required to attract new management required to effect the change in strategy/performance.

Technology/Life Sciences:  These industries are known for high risk/high reward – particularly in the pre-IPO stage, where large equity grants are the rule.  These grants are either very valuable or worthless.  (Executives that have worked in these industries often have enough worthless stock option certificates to wallpaper their office.)  Relative TSR plans can replicate this highly leveraged reward practice in the public company stage.  Very successful strategies produce high relative TSR, which these plans magnify into even larger reward.

In Conjunction with Other Plans:  When other long-term plans are in place that use other metrics, a TSR plan can be good for balancing the total plan so that a company doesn’t create negative perceptions that management gets very generously rewarded when shareholders don’t.

Are relative TSR plans “the answer”?  No, they are “an answer” that can be very appropriate in the right situations.

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“Say on Pay”: Paul McConnell interviewed by Marketplace Morning Report

Posted by Paul McConnell on April 19, 2012  /   Posted in Compensation Committees

“Citigroup Investors Push Back on Exec Pay Packages”

Board Advisory’s own Paul McConnell, Managing Director, was interviewed by Marketplace Morning Report on April 18, 2012.

For Full Story & Audio/Video see the Marketplace website:


Bob Moon: Citigroup investors just pushed back on outsized executive pay. Fifty-five percent of the bank’s shareholders voted against pay packages for top execs, including $15 million in compensation for CEO Vikram Pandit. The vote is advisory only, though, and thus doesn’t actually force a change in Citi’s pay practices. So what will it accomplish?

Executive compensation expert Paul McConnell is on the line with his take on the message it sends. He’s managing director at Board Advisory LLC. Glad to have you join us.

Paul McConnell: Thank you.

Moon: I’ve seen stories that Citigroup can go ahead and stay with its pay practices in spite of this vote. If this doesn’t change things, what might?

McConnell:  Well, it is an advisory vote, which means it’s non-binding on the board. But it’s non-binding in the sense that the pay is not going to be taken away as a result of this. The board will react to this; no board is going to take a “no” vote from shareholders and ignore it. If they were — which is, I think, first of all not going to happen –but if they were, the next step with shareholders would be to vote the board members out.

Moon: Do you think the attention this is getting might touch off some kind of shareholder revolt at other companies over these pay packages?

McConnell: I mean, first of all, you’ve got to understand — the Citi corp. pay package is not outrageous in terms of the amount of pay. I think the issue at Citi corp. is more, shareholders are questioning the relationship between pay and performance.

Moon: So these Citi shareholders are basically saying: You want this, you’ve got to earn it?

McConnell: They’re unhappy with that subjective approach. They think the standards are probably not high enough for the amount of compensations earned.

Moon: But you don’t think this reflects general angst among shareholders in general — not just at Citi?

McConnell: No I do not. As a matter of fact, the reason for that is that corporate America has done a pretty good job over the last two or three years in removing most of what are known as “problematic pay practices,” that were really making shareholders irate.

And also you’ve got to understand with Citi, there could be a lot of other things rattling around here. Citi is an organization that’s had its share of troubles over the last few years. And they’re basically telling the board that something is wrong and they want it fixed. And the board will probably make some changes in the pay programs in reaction to this.

Moon: Paul McConnell at Board Advisory LLC. Thanks for your insights.

McConnell: You’re welcome.

© 2012 Board Advisory.
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