Performance share grants have become popular awards for senior executives that companies make to improve alignment of executive pay, company performance, and shareholder value. While the theory behind them is sound, there has never been total agreement about how effectively these grants actually achieve their objectives.
The question of whether performance shares really result in pay for performance is at the heart of evaluating the effectiveness of these awards and their design. While it is hard to guarantee that these grants, or any other grant types, will truly drive better executive actions and decisionmaking, companies at least want some correlation between higher payouts and higher corporate performance. We have considered this question in other commentaries at the myStockOptions.com Blog: Do Performance Shares Actually Perform? and As Performance Share Awards Gain Widespread Popularity, Some Question Whether They Truly Improve Corporate Performance.
Three Truths And A Lie: New Research On Performance Share Grants
In a white paper on performance awards (Performance Awards: 3 Truths And A Lie?), Fidelity Stock Plan Services and ClearBridge Compensation Group apply survey results in an attempt to assess the alignment between performance award payouts and company performance. The title of the paper plays off of the popular party icebreaker game called "2 truths and a lie." The "three truths" show some interesting correlations:
1. Payouts and company performance awards are directionally aligned, but not perfect. About two thirds of the awards line up with performance (i.e. the higher the company performance, the higher the pay, and vice versa), measured by either total shareholder return (TSR) or earnings per share (EPS). The pay-for-performance alignment was 68% for TSR and 62% for EPS. In addition, payouts at high-performing companies were more aligned with performance than those at low-performing ones were. The study notes that, given those results, these awards are not a "silver bullet" way to achieve pay for performance.
2. Metrics matter. Companies often use multiple metrics, which occur at 42% of the surveyed companies. TSR at 68% had the strongest relationship between payouts and performance, while revenue performance had the weakest (51%).
3. The LTI grant mix can be related to company performance results. 73% of the surveyed companies grant restricted stock or options along with performance shares. High-performing companies tend to include performance awards and/or stock options in the mix more often than low-performing companies do (92% versus 81%).
Stock Options Still Rock
The "lie" was a surprise to the researchers: the idea that stock options do not function as a "performance" grant is inaccurate. In fact, the study found the opposite. Options continue to be an "enduring choice," providing direct alignment with shareholder value creation, making them "worth another look," as the authors recommend.