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03/22/2016

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Thanks Stephanie,
Companies have to look at how their performance correlates to TSR before using it. Some companies are market leaders and influence the TSR of others in their industry and others don't correlate as well. TSR seems like a great metric on the surface but may not be the right metric for every company when you dig deeper.

You are certainly correct on your observations. Executive compensation and measuring executive performance in a constructive way is a 'slippery slope' at best.

Perhaps the folks who 'discovered' the 'sticks' that were used to find water underground in the 1700s could be recruited to address executive compensation. Or how about the people who read fortunes by feeling the bumps on your head?

Good parallels here with other pseudosciences. Some farmers still use dowsers. Phrenology had adherents until the last century, too, despite the failure of either approach to meet scientific standards of accuracy. Same applies to many of the arcane rituals performed in board rooms today, I suspect ... even though they may share similar traits. Much is claimed but little is proven. Basic research like this is vital.

TSR...
First, the SEC has jumped on the TSR bandwagon fairly aggressively. https://www.sec.gov/news/pressrelease/2015-78.html. Companies will need to communicate the link between TSR and executive compensation even if they don't use it as a measurement for executive compensation.

More importantly TSR is a great metric for nearly every publicly traded company, but that does not mean is converts well into a goal for executive compensation. I wrote a bit about that issue here: http://www.compensationcafe.com/2014/06/relative-tsr-is-a-bit-like-cough-medicine.html

The research cited shows that the companies using TSR tended to be larger and less profitable. This does not surprise me. Those types of companies have: 1) the scrutiny from investors, 2) the budget required for this often expensive plan design process, 3) the need to justify leveraged payouts, when earnings may not explicitly support them.

The lack of correlation between the plans and performance has been shown in academic papers and consultancy whitepapers in the UK and elsewhere for at least 10 years. In looking at this prior research one clear issue came to the forefront. These plans, for relatively equal companies, are not designed equally.

Peer groups (size, adjustments etc.) used are fairly imcomparable from company to company.
The percentile targeted for 100% achievement ranges widely.
The amount of leverage for over and underperformance does not track well from company to company.

Those three factors alone would lead to a wide range of potential payouts for very similar companies. Throw in volatile stock prices and the other list of variables and features for this kind of compensation and consistency goes out the window.

I agree with Stephanie that "executive pay for performance is hard to tackle" an that "simple and direct". Big companies are complex. The stock markets are complex. Measuring performance is complex. Equity compensation is complex. While simplicity may be a goal, it should override effectiveness.

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