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TSR Modifiers Gain Popularity as a Gauge to Adjust Performance Grants

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March 7, 2022

Thanks to MyLogIQ

Methodology and Key Takeaways

Using the CompanyIQ platform, MyLogIQ reviewed three years of long-term incentive award metrics for Russell 3000 (R3000) companies during compensation years 2018, 2019 and 2020. Companies that filed their most recent proxies by 12/1/2021 were included in the results.

Key Takeaways:

Modifying award payouts based on total shareholder return (TSR) performance is gaining traction in the R3000 where 12% of companies used a TSR modifier in their 2020 executive compensation metric portfolio.
Four out of five TSR modifiers were linked to TSR performance relative to a group of comparator companies, rather than on an absolute basis.
Target performance was set at the 50th percentile for 79% of relative total shareholder return (rTSR) modifiers, but R3000 boards assigned target performance above the median for 18%.
The most commonly assigned rTSR modifier payout adjustments were -25%, 0%, and +25% for threshold, target, and maximum performance, respectively.

Introduction

TSR, a measurement of income derived from and capital appreciation of an investment, gained prominence since the introduction of Say on Pay votes as a means to link the performance of a company’s stock price with the payouts of long-term equity awards granted to top executives. Well over half of companies in the large-cap indices now utilize TSR as a metric in their long-term plans. Moreover, using TSR performance to adjust final payouts of awards previously determined by other metrics, rather than a discreet and weighted metric itself, has grown increasingly popular with 12% of R3000 companies using these TSR modifiers.

Data and Analysis

Rather than weighting TSR to determine a payout on a portion of an award, e.g. linking 33.3% of total potential shares to TSR performance, TSR performance instead determines a final adjustment to the value of the award, e.g. -25% for poorer results and +25% for superior ones. Utilizing the CompanyIQ® platform, MyLogIQ found that the proportion of R3000 companies that used a TSR modifier grew by two percentage points per year from 2018, when 8% leveraged a TSR modifier, to 2020 when that figure was 12%. (Fig 1)

Fig 1 - Russell 3000 TSR Modifiers

TSR performance is typically measured relative to a performance peer group, which can be a designated custom group of performance peers selected by the board or a stock index such as the S&P 500. For example, a board can target 50th percentile (pctl) TSR performance within a group rather than an absolute TSR goal. In 2018, 72% of R3000 TSR modifier metrics were relative. In 2020, 80% of metrics were rTSR. (Fig 2)

Fig 2 - Russell 3000 Relative TSR Modifiers

In order to determine a final adjustment to payouts, boards must designate performance hurdles, or goals.

Threshold Performance Hurdle - A large majority (79%) of R3000 companies that used an rTSR modifier set the 25th pctl as threshold performance, where negative payout adjustments are the greatest.
Target Performance Hurdle - Target performance typically fell at the 50th pctl (79%), though a substantial 18% of modifiers targeted above median TSR performance.
Maximum Performance Hurdle - 86% of rTSR modifier metrics used the 75th pctl as maximum performance, where better performance ceases to adjust the award payout higher. (Fig 3)

Fig 3 - Russell 3000 Relative TSR Modifiers Performance Goals

Payout adjustments linked to performance goals for rTSR modifiers in the R3000 are shown below in Fig. 4. Boards typically linked a negative 25% or 20% adjustment to threshold performance (76%) and the reciprocal +20-25% to maximum performance (74%), though +/-50% adjustments were not uncommon. Target performance resulted in a zero percent adjustment to the final award 91% of the time. (Fig 4)

Fig 4 - Russell 3000 Relative TSR Modifiers Payout Adjustments

Conclusion

Choosing performance metrics has important ramifications for executive compensation stakeholders. While linking TSR performance to award payouts has gained prominence, a growing minority chose to leverage TSR in a unique way – as a modifier to final award payouts rather than as a discreet, weighted metric.

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