June 30, 2008
Reported or Adjusted Results?
In my experience, relative financial comparisons become very complicated and lose credibility with the compensation committee and senior management team when the results are skewed by unusual items. For example, if a peer company had an asset impairment last year, this year’s ROIC may be at the top of the peer group. Why? Not because of improved financial performance, but because its capital has been largely written-off. Thus, even a modest profit makes the company look like it is batting .400.
Do you adjust for this, or simply use the “as reported” figures? Same goes for companies that have unusual gains or losses, severance costs associated with a plant closing, etc. If you decide to adjust for these items, you often end up having to restate the financials for the entire 15-20 company peer group. If you decide to “play it where it lies” you may unjustly penalize or reward your executives.
My Preference: Generally, I prefer to use relative TSR based on the same peer group used for compensation purposes and three-year budgeted financial goals (like cumulative EPS or 12% ROIC). That way, management is being rewarded based on both a shareholder friendly measure (i.e., TSR) and a measure that they can more directly influence (e.g. a three-year internal goal). Although this approach has its own set of challenges and issues, it has served my clients and their shareholders pretty well over time.
– Mike Kesner, Deloitte Consulting