Debating the Role of TSR in Executive Compensation

April 1st, 2015 | By

Using total shareholder return (TSR) as a compensation program metric emerged as a hot topic for both panelists and attendees during the third annual Leading Minds of Compensation event last week at the Grand Hyatt in New York City. Discussing the day’s most pressing compensation issues in a panel selected  by NACD Directorship magazine Publisher Christopher Y. Clark and Editor-in-Chief Judy Warner were: Steven Hall, managing director of Steven Hall & Partners; Dayna Harris, vice president of Farient Advisors; Jeff Joyce, partner of Pay Governance; Rose Marie Orens, senior partner at Compensation Advisory Partners; Jannice Koors, managing director of Pearl Meyer & Partners; and Barry Sullivan, managing director of Semler Brossy.

Jannice Koors noted that, while not a practice used by the majority of public companies, TSR is a popular metric. “It has some benefits: it clearly is the most directly aligned metric between shareholders and executives, so it’s an easy story to tell, it rewards results, it’s easy to present to shareholders.” But, according to Koors, the pros of TSR are readily outweighed by the cons. “The purpose of an incentive plan is to incent behaviors, actions, and decision making,” she said. “You don’t have behaviors that create stock price.” Dayna Harris agreed. “TSR doesn’t focus people on things they can control,” she said. “When you go to a one-size-fits-all compensation plan, you are reducing the number of tools in the tool chest that help the board and management to improve overall company performance.”

Koors expressed another major reservation with this metric. “You’re measuring movement over that period of time—it creates some natural spikes. So what goes up must come down. What naturally happens in TSR plans—and what a lot of companies who are coming up on that third and fourth and fifth year of having a TSR plan in place are finding—is that if you’re in the top quartile at the end of your three years, you have vastly improved the likelihood that you are going to be in the bottom quartile at the end of your sixth. So what TSR really rewards is being a steady eddy in the middle of the pack.”

But, during the Q&A portion of the event, one director self-identified as an advocate for TSR as a valid and valuable metric, said it’s the purest way to align shareholders with directors. If companies were to move away from TSR, what data is available to lure away TSR’s most ardent adherents? “I’m not going to try to dispel the notion that it is purely aligned,” Koors said. “I’m just saying it’s a reward, not an incentive—and it depends on what you want your long term incentive plan to do.”

Rose Marie Orens added her thoughts about TSR, saying that there is a time and a place for this metric, particularly in the financial services industry. Though acceptable to use TSR as a portion of an award, and to use it as a reminder that driving stock prices is a priority for executives, Orens didn’t think it should be used as the main metric behind executive compensation. “I would drive either for relative performance on metrics that are important in my industry and I want to demonstrate that I am doing better,” Orens said.

Barry Sullivan directed attendees’ attention to “The Problem with Total Shareholder Return,” a study mounted by his firm in 2012 that gave Koors’ intuition and Orens’ observations a statistical bite. “What do we need to do from a growth and profitability perspective over a long period of time to drive TSR?” Sullivan asked. “When you look at the data, those companies that outgrow at a return above their weighted cost of capital drive superior total shareholder return. Focus on growth, focus on profitability, and TSR will come.”

Jeff Joyce didn’t take issue with TSR in and of itself, but rather, he found fault with its application. He observed that, because TSR is measured over a fixed period of time, a sudden lull in stock price at the end of that period undermines shareholder alignment. “While it does play a role, stock price is captured in other forms of equity,” he said. “It doesn’t have to be explicitly measured in terms of total shareholder return.”

NACD Directorship will host a “Prognosticators of Pay” event on July 17th in Seattle. Directors interested in attending this complimentary program may request an invitation online.

Look for full coverage of NACD’s Leading Minds of Compensation event in the May/June 2015 issue of NACD Directorship magazine.

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Economic and Geopolitical Disruptive Forces: History Favors the Best Prepared

March 17th, 2015 | By

Now in its third year, NACD’s Directorship 2020® takes an investigative look at the trends and disruptors that will shape boardrooms agendas of the future. This initiative is designed to raise directors’ awareness of these complex emerging issues and enable them to provide effective guidance to management teams as they navigate the associated risks and opportunities.  The inaugural 2015 session was held on March 3 at the Grand Hyatt Hotel in New York City, where subject-matter experts from Broadridge, KPMG, Marsh & McLennan Cos., and PwC and corporate leaders explored the boardroom implications of geopolitical and economic disruption.

Illustrating the boardroom perspective on the impacts of economic and geopolitical disruption on corporate strategy.

Illustrating the boardroom perspective on the impacts of economic and geopolitical disruption on corporate strategy.

In his remarks on economic disruption, Peterson Institute for International Economics Visiting Fellow and International Capital Strategies Executive Chair Douglas Rediker examined the changing face of global competitive markets. Governments around the world are increasingly involved in market activities and are more likely to champion domestic businesses or businesses based in countries with which they have trade agreements. This situation creates a business environment in which companies seeking to expand must assess a foreign country’s protected business sectors in order to fully evaluate the endemic risks and opportunities.

Taking a geopolitical perspective, UBS Executive Director and Head of U.S. Country Risk Dan A. Alamariu considered the ripple effects of government regulation, using a case example of the sanctions recently imposed by the US and EU on Russia. Though these measures did diminish the buying power of the ruble, the sanctions also hurt Western companies operating in Russia because consumers could no longer afford to purchase foreign goods. He cited other examples as well. In its efforts to recover from the financial crisis, the Chinese government has recently implemented a number of economic reforms. While these reforms may succeed in re-establishing China as an “engine of growth,” the infighting that they have triggered among political elites could ultimately dampen growth and set the country on an uncertain course. Closer to home, persistent gridlock in the US government is preventing needed progress on issues critical to the business community, such as tax policy and infrastructure.

Both speakers alluded to the fact that as countries become more divided and inwardly focused—both internally and with respect to international relations—developing collective approaches to major transnational issues such as climate change and cyberattacks will become more challenging. Companies will therefore need to devise their own strategies for addressing these challenges.

Economic and geopolitical disruptors are inextricably linked, and the three main takeaways from both sessions are as follows:

  1. Embrace risk—you may discover opportunities. Directors need to start thinking like emerging markets investors. In other words, they should get comfortable working in a business environment that is volatile and unpredictable. This breed of investor has historically been focused on domestic, regional, and international political and economic risks. Because technology has created a world that is deeply interconnected, investors must proactively cultivate an understanding of geo-economic risks. By extension, it is also important to recognize technology as a major disruptive force that will continue to impact companies across all sectors. For example, tablet devices have completely changed not only how people communicate and access multimedia content but also how companies conduct business. By embracing disruptive technology, companies can in turn create the caliber of differentiated products that will transform the marketplace.
  2. Be prepared. This ageless scouting motto is especially relevant to anyone managing or overseeing a company. Businesses the world over are more interconnected than ever before, which forces companies to compete across national borders and exposes them to international political and economic risks. Boards need to consider the ultimate “black swan” events that could affect their companies. By extension, directors need to be mathematically literate—if they are not already. Black-swan events include natural disasters, such as Hurricane Sandy, which incapacitated businesses in our nation’s financial epicenter; political events, such as the outbreak of war; economic unpredictability; and technological innovation, which we have seen from the automobile to the iPad. Having a by-the-numbers plan for how the company could behave in specific scenarios will create a comprehensive understanding of the risks the business faces. Because it’s impossible to completely protect a company, it is essential to create resiliency. The board must therefore ensure that incident response plans are in place and must routinely test those response plans to confirm that they meet the company’s evolving needs.
  3. Beware of “herd mentality.” Directors need to periodically review the current board composition; and if there are gaps in the board’s collective knowledge that may prevent it from assessing areas of risk, it may be in the board’s best interests to bring in a third-party expert to help inform boardroom discussions. This is especially true of cyber risk. Many boards are still struggling to comprehend the depth and breadth of these threats, and because it’s neither possible nor desirable for every board to have a cyber expert in their ranks, it is imperative to bring in outside sources to inform and educate directors and management.

Look for full coverage of this NACD Directorship 2020 session in the May/June 2015 issue of NACD Directorship magazine. For information on future events and recaps of past events, visit the NACD Directorship 2020 microsite.

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Wanted: 50 Exemplary Directors, And More

March 6th, 2015 | By

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The NACD Directorship 100 is the preeminent annual list of the most influential people in the boardroom and corporate governance and we are calling on all public company directors and NACD members to tell us who you think deserves recognition. Online nominations are being accepted until 5 p.m. EST on March 31, 2015. You don’t have to be a director in order to participate. Sending a nomination takes only a few seconds and you can nominate as many individuals as you think worthy.

From its inception in 2007, the objective of the NACD Directorship 100 has been to elevate the directorship role by profiling exemplary directors and the governance institutions and related professionals who influence board agendas. There are three categories of recognition within the NACD Directorship 100 leadership awards:

  1. The B. Kenneth West Lifetime Achievement Award
  2. The NACD Director of the Year
  3. The NACD Directorship 100, which encompasses three sub-categories:
        • The NACD Corporate Governance Hall of Fame
        • Directors
        • Governance Professionals

The B. Kenneth West Lifetime Achievement Award honors a single individual who has served on a public company board in a leadership capacity, such as board chair, lead director, or committee chair, or has been a leader in a corporate governance capacity. In 2014, we honored former Delta Chair Paula Rosput Reynolds. To be considered in this category, nominees are required to have additional documentation, including testimonial letters from colleagues or peers. The full selection criteria are available here.

The NACD Director of the Year is a director in a board leadership capacity on a public, private, and/or not-for-profit company. The 2014 recipient of this award was former Lone Star Chair and CEO Rhys J. Best. To be considered in this category, nominees are required to have additional documentation, including testimonial letters from colleagues or peers. The full selection criteria are available here.

The NACD Directorship 100 Corporate Governance Hall of Fame recognizes three to five individuals who are or have been a director in a board leadership capacity or a leader within an organization influencing corporate governance. These individuals are widely recognized and acknowledged by their peers as having made an indelible and lasting contribution to the field of corporate governance as demonstrated by their exemplary, ethical service on either their boards or for the governance organizations they serve.

Since its inception in 2008, the NACD Corporate Governance Hall of Fame now counts among its honorees such legendary corporate officers as Vanguard Founder John Bogle, Berkshire Hathaway’s Warren Buffett, Young & Rubicam’s Ann Fudge, and GE’s Jack Welch in addition to legal titans H. Rodgin Cohen, William B. Chandler, Martin Lipton, and Ira Millstein. In 2014, we inducted three governance luminaries: Catalyst’s Ilene Lang, former U.S. Secretary of Commerce and NACD chair emeritus Barbara Hackman Franklin, and the Honorable Myron T. Steele.

The NACD Directorship 100 recognizes a unique class of 50 outstanding directors currently serving in a public company board leadership capacity. Nominees must possess a sound ethical compass, be involved in board-related issues and activities outside of the boards on which they sit, and serve as models for their director peers. Nominees who have been honored in the director category in previous years are not eligible for consideration. Our evaluation process ensures a unique class of directors each year.

NACD Directorship 100 Governance Professionals are leaders representing no more than 50 organizations from relevant and related corporate governance advisory fields, encompassing attorneys, compensation consultants, audit firms, recruiters, investors, journalists, and policy advisers.  Individuals nominated in the governance professional category must demonstrate exemplary, ethical service for their organizations, support NACD’s mission, and engage outside of their companies to train others on what constitutes good governance practices.

Nominees in all categories will be vetted by NACD Directorship editors then submitted to NACD’s board of directors for endorsement.

The full 2015 NACD Directorship 100 list will be published in the November/December issue of NACD Directorship magazine. Honorees will be notified in advance. In addition, directors and professional stakeholders will convene to celebrate this year’s honorees at a black-tie gala event to be held on December 2, 2015 at Gotham Hall in New York City. This exclusive invitation-only event will be a prime opportunity to meet your peers in the director and governance communities and to raise a glass to outstanding achievement.

Questions about the nomination process for Director of the Year and the B. Kenneth West Lifetime Achievement Award should be directed to Chris Barnard at pcbarnard@NACDonline.org.

All other questions may be directed to me, NACD Directorship Editor in Chief Judy Warner, at jwarner@NACDonline.org.

Along with everyone here at NACD, I’m looking forward to receiving your nominations and to taking yet another opportunity to celebrate the unwavering stewards of American business.

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