Written by Bruce Brumberg, Editor-in-Chief of myStockOptions.com and myNQDC.com
As the editor-in-chief of myStockOptions.com, I probably spend too much time thinking about stock compensation. For something a little different, I recently attended the annual conference of the Investment Management Consultants Association, which was held in Boston (our hometown). There I attended a provocative talk given by Michael Sandel, a Harvard professor and the author of the book What Money Can't Buy: The Moral Limits of Markets. Maintaining that everything nowadays can be bought, even morality, Professor Sandel asserts that we have moved from a having a market economy to being a "market society"—and he goes on to consider whether there are things money shouldn't buy.
Perhaps predictably, I soon began thinking about the implications for stock compensation. Professor Sandel's ideas brought to mind a recent study of performance share grants released by the consulting firm Arthur J. Gallagher & Company (The X Factor: What LTI Measures Drive Corporate Performance?). The authors of the paper, compensation consultants James Reda and David Schmidt, seem to indicate that companies are trying to "buy" superior executive and corporate performance with performance share grants—and that in many situations they are not getting their money's worth.
The authors tried to assess whether the use of performance-based awards, particularly those based on total shareholder return (TSR), actually help to improve company performance. They analyzed data from the 200 largest US companies, which have an overall average TSR of 1.15%. Their findings include a number of surprising revelations, such as the following (results varied by industry).
- 53% of the companies used a TSR performance measure at least once in the 2008–2012 period, with an average five-year TSR of –0.18%. Companies with long-term incentive plans not using TSR had an average return of 2.67%.
- Companies that did not grant performance-vested incentives for any of the five years had average returns of 2.54% (but –0.47% if you leave out Apple and Amazon).
- 37% of the companies used an EPS measure at least once in the 2008–2012 period, with an average five-year TSR of 1.37% (the only performance measure that beat the overall TSR average of 1.15%).
- 44% of the companies used a measure involving capital efficiency (e.g. return on equity, return on invested capital). They had an average 0.68% TSR during the study period.
- 56 of the companies that used the same metric over the five-year period (instead of changing measures) experienced a 5.09% TSR.
The authors conclude that their results raise questions about whether performance-based equity awards really lead to better corporate performance than time-based grants do.
Even as the use of performance-vesting awards and TSR metrics continues to grow among companies (and gain popularity with institutional investors), Mr. Reda and Mr. Schmidt offer some pointed insights from their research on the observable value of performance awards. "Since we did not find overwhelming evidence that using performance-based grants will result in improved company results," they assert, "companies need to understand as clearly as possible which measures are most likely to motivate executives and positively affect company performance as measured by long-term TSR. Our analysis strongly suggests that companies need to figure that out and then stick with it over the long haul."