The Advisors' Blog

– Liz Dunshee

A recent analysis of 250 large public companies found that nearly all use a 3-year period for “long-term” performance awards. In this article, Tom McNeill & Jon Szabo of Meridian Compensation Partners examine why this is the case – and what companies can do to break free of the norm.

Among other factors, they note:

A practical issue is the need to set fixed, three-year financial goals when using a performance award. While most (85%) companies set multi-year goals, a vocal minority have succumbed to the challenges and uncertainty of setting goals three years into the future, by using an average of three one-year goals. Extending the performance period beyond three years would only serve to increase the challenge and uncertainty of this situation. Resorting to one-year goals set annually will usually result in the proxy advisory firms making adverse comments on this approach.

However, the goal-setting argument does not work when relative TSR is the performance measure (it’s the most prevalent measure, used by 57% of companies). Since no goal-setting is required, decisions instead focus on the shape of the award payout curve – generally defined by the company’s percentile positioning or ranking versus peers. One could argue that for relative TSR plan designs, it should be easier to use a longer performance measurement period. Yet, only 2% of companies have performance periods longer than three years.

I blogged last week that TSR’s popularity is leveling off – maybe this is an argument for keeping it around. In any event, for companies considering a shift to longer-term performance periods – ongoing communication with investors & executives will be key.