Design Attribute Checklist for Relative TSR Awards

Back by popular demand and refreshed for December 2018, this checklist has also appeared under the title, “TSR Award Management Checklist: From Design to Tracking.” 

Relative total shareholder return (rTSR) remains far and away the most popular metric for performance-based awards, even as its role in the long-term incentive portfolio evolves to best fit its strengths and weaknesses. On the one hand, rTSR directly links pay to shareholder value creation. On the other hand, the awards can be hard for executives to understand, leading them to treat the awards as lottery tickets.

Intensifying these challenges are the underlying calculations, which involve complex references across potentially dozens of peer firms and can be prone to error. These errors can show up in the upfront valuation. They can also creep into the post-grant tracking, which is a terrific way to foster skepticism and mistrust among the recipients of rTSR awards. Errors in post-grant tracking or payout calculations can in turn lead to financial statement problems, making this a shared risk between executive compensation and financial reporting professionals.

[TSR performance tracking: managing the peer list]

[Calculating total shareholder return]

As it stands, the evolution of rTSR awards is trending toward companies issuing “hybrid awards.” These instruments include rTSR plus one or more operational metrics, and strike a balance that maintains the benefits of rTSR while mitigating the downsides.

[Hybrid awards: the next generation of performance-based equity]

In the meantime, if your company has committed to rTSR, none of that matters. What does matter is this: How do you track and communicate rTSR awards effectively? How do you keep them top-of-mind for the executives who receive them?

We’ve learned a thing or two from working with hundreds of companies on their rTSR award design and implementation. One of those things is that the upfront valuations and post-grant assessments of current performance are worth doing correctly and communicating to the right stakeholders early.

[Maximize the perceived value of TSR awards through post-grant tracking]

That requires a streamlined and controlled process for tracking rTSR. We support our clients primarily via our web-based platform, AwardTraq. But even with automation, there’s no substitute for judgment and process clarity.

To help you with this, we’ve created a checklist of the award attributes that give rise to problems. When should you use it? First, use it upfront during the award design process. Consider all relevant angles in setting award terms and appropriately capturing them in a grant agreement. Second, use it during review of an ASC 718 valuation report or when setting up a post-grant tracking process. Verify all the substantive award features are being correctly handled, especially when unique situations arise with your company or a peer.

One of the benefits of a checklist is that it helps identify ambiguities or omissions in an award grant agreement. These problems are common, since grant agreements are drafted by attorneys who are either working from condensed compensation committee meeting minutes or a high-level PowerPoint presentation on the intended award design. For example, one of the major sections of the checklist concerns the treatment of peer firms that are acquired or delisted during the performance period. Many grant agreements are silent on whether the peer firms should be excluded altogether or have their performance counted through the date of the corporate action.

We invite you to reach out with any questions or to discuss your particular award situation with us.