The Advisors' Blog

Over half of S&P 500 companies use relative total shareholder return in their long-term incentive plans – but this Compensation Advisory Partners memo points out that rTSR’s simplicity can be deceptive, so the way your company is using this metric could require a second look. Here’s an excerpt:

The first decision is whether to use rTSR as a primary weighted metric or as a modifier to other financial results.

Most companies give rTSR a prominent role, with 68% using it as a weighted metric, meaning it directly determines a portion of the PSU payout. While 50% is the most common weighting (38% of companies), practices diverge sharply on either side. About one-third lean heavily on rTSR, with 22% weighting it at the full 100%. At the other end, 29% set it below 50% — and only a small minority, 13%, drop below 33%, most often at 25%.

When rTSR is a weighted metric, nearly nine in ten companies measure performance as a percentile rank within their comparator group. The median payout scale begins at the 25th percentile for threshold, reaches the 50th percentile for target, and tops out at the 80th percentile for maximum payout. While the traditional 25th / 50th / 75th percentile performance goal scale remains the single most common approach (31%), it is no longer majority practice, as more rigorous maximum goals have become increasingly common.

The memo goes on to describe other variations of using rTSR as a weighted metric, and how this differs from a modifier approach – which is used by 32% of applicable S&P 500 companies. The memo says that weighted metrics make rTSR a central driver of payouts – whereas a modifier reinforces financial or strategic goals – so companies should think about their overall compensation philosophy when choosing an approach.

The memo also discusses the next major decision point for rTSR metrics – the comparator group. Here’s an excerpt about that:

The trade-off is clear: indices are transparent and objective but may be less relevant for companies in niche sectors, while custom peer groups can provide a sharper performance comparison and the ability to control the sample size but require more judgment and justification in their selection.

CAP cautions companies using sector indexes to carefully consider the constituents included, as they may be reclassified over time.

These issues with rTSR aren’t new – Meredith blogged about potential improvements to tech industry incentive plans a few months ago, and I swiped today’s headline from a blog that Broc wrote back in 2018! But if it’s been a while since your compensation committee considered how rTSR is used, it may be time to revisit the discussion. Members can visit our “Determining How Much Pay is Appropriate” Practice Area for more resources on design issues and trends.

– Liz Dunshee