June 27, 2024
TSR A-OK for LTI
As Meredith blogged about earlier this year, the use of relative TSR remains a popular method for awarding exec comp and not just for tech companies. Willis Tower Watson found in its latest LTI Policies and Practices Survey Report that TSR is the predominant performance metric in long-term incentive (LTI) awards.
Last week, WTW published an article concluding that, for TSR-based LTI awards, “[t]here almost always is a fair value premium over the underlying stock price for each target unit granted, and it often can be significant.” This is important for compensation accounting and disclosure purposes. WTW looked into why those premiums exist and ran a simulation to test whether the Monte Carlo method used to value the awards is working appropriately. Here’s what they concluded:
As relative TSR prevalence in LTI award designs continues, valuation questions and skepticism inevitably will continue among companies and executives. This analysis supports the theory that valuation premiums for TSR-based awards are appropriate. The Monte Carlo method is working as intended to capture the true value of these award designs. If your organization is concerned about the level of valuation premium, consider exploring plan design alternatives to evaluate the tradeoff between a plan’s potential value and the associated accounting value.
Fair warning: This article gets deep into the math around fair value premiums. Despite being a (super cool) former high school mathlete, I found it rather hard to follow in a quick read and was thankful for the TL;DR of “The Monte Carlo Method is working” at the end.
— Meaghan Nelson