Do Performance Shares Actually Perform?

In a performance share grant, you receive the shares only if specified performance goals are met within the measurement period set forth in the grant. Technically, these grants can be in the form of performance stock awards (PSAs), which are similar to restricted stock, or performance stock units (PSUs), which are similar to restricted stock units. Either way, the shares are not paid out unless the company scores the touchdown outlined in the playbook of the stock plan. Whether the field is big or small, that gives employees and executives an extra incentive to get the ball into the end zone.

The 2016 Domestic Stock Plan Design Survey, conducted by the NASPP and Deloitte Consulting, shows a big increase in the use of performance share awards, especially those with total shareholder return (TSR) as a metric. However, even though these grants generally foster the pay-for-performance conditions that shareholders and proxy advisory firms want, we have recently sensed some rumblings of discontent about performance share awards among commentators on compensation issues. One consultant has concluded, for example, that companies can reduce complexity and streamline their compensation by returning to stock options, which he regards as a "much simpler way to reward executives than performance shares based on TSR" (see Is It Time To Simplify Your Design? by Eric Hosken, workspan, July 2017, pages 41–44). The author also reasons that executives find it much easier to "relate to an absolute stock price objective than an always-evolving relative performance standard."

Skepticism about performance shares is coming from many different angles. Writing in the July–August issue of Harvard Business Review, MIT professors S.P. Kothari and Robert Pozen (a former executive chairman of MFS Investment Management) criticize performance share plans, including their design and disclosure (see Decoding CEO Pay). In the sample plan that they evaluate, 50% of each grant is based on "adjusted operating cash flow," which the authors could not find a definition of in the proxy statement. While it was in an exhibit in the 10-K, there was no quantification of what it means or its implications for the company or executive compensation. The other 50% of the grant, they noted, is tied to TSR relative to 11 peers over a three-year period. Although the company's annualized TSR ranked 10th, the CEO still received 80% of the target payout. The authors opine that this is not truly "pay for performance." Instead, they reason, if the TSR ranks in the lower half of the peer group, the payout should be less than half. These respected authors lament that this "generous treatment" of weak performance on relative TSR is far from rare. While CEOs get large payouts for outperforming a peer group, they are only modestly penalized for underperforming.

For details about performance share grants, see the articles and FAQs about them at myStockOptions.com, including an FAQ with survey data on the most common metrics used for these grants.

Comments

[Dan Walter]

So many potential comments here...I will try and stay high level

TSR: Not a great stand alone goal. Never has been and it was only pushed by math experts who saw the predictability in accounting consequences while ignoring the behavioral economics impact.

Undefined metrics. This is usually done to provide some form of unmonitored discretion. Not a great habit, but also not a common one.

a TSR plan that pays out 80% of Target when performance in the bottom 20% of peers. 1) We do not know if the grant size was intentionally small to make up for this pseudo-guaranteed payment. 2) We do not know what the upside potential or curve was. Perhaps the entire award was small and the TSR goal was really a nod to performance units, while the company was trying to transition from time-base RSUs. 3) Perhaps the company had never been above last place and even one step up the ladder was a measurable improvement.

We try to paint executive compensation with one big brush. When we do that only the lucky win.

On the flip side of this is the fact that Performance Units often do work well. Yes, they require more effort, but as one CEO told me, "Just because it's hard doesn't mean we shouldn't do it."

These awards require planning, commitment, communication, more communication, honesty, integrity and a human factor.

[Don Nemerov]

the challenge of performance share plans is the many design variables and modeling required vs "plain" vanilla stock options; good in concept, hard in execution. Data has shown that these plans have increase exec payouts relative to shareholder return as a faster rate than options would have due to the many design challenges. Data also has shown that RTSR plans have been the worst plan design ever from a shareholder perspective, yet the most common plan in practice today. Too much "me too" in the Compensation and Board worlds.