Credit Suisse looks at TSR peer groups and LTI vesting
04/05/2015
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Credit Suisse has released research that reinforces earlier findings that differing peer groups for relative TSR comparisons can result in anomalous LTI vesting outcomes. That is, good performers in absolute TSR terms may not have LTI vest, whereas poorer performers would.

Their research focused on ASX 200 oil and gas (O&G) companies. These companies’ relative performance varied depending on the peer group used. As a consequence, some companies with better absolute TSR performance would not have had their LTI vest whereas other companies with poorer absolute TSR performance would have had at least some LTI vest.

Note that Credit Suisse did not replicate the performance measures used by O&G companies. They appear to have used the arithmetic average of TSRs for companies in each group to illustrate how different groups can produce different returns. Vesting outcomes may be quite different if the actual methods used by the various companies were replicated. That is, the O&G companies using relative TSR either based vesting on:

  • A TSR percentile rank
  • TSR % return relative to a market weighted accumulation index return.

For example, a company can be below the arithmetic average TSR but still be at or above the 50th percentile rank at which vesting will occur. Similarly, the weighted index return could be quite different to the arithmetic average return of companies in an index. Despite this, the points made by Credit Suisse remain valid.

Valid points made by Credit Suisse include:

  • That although all the companies were considered O&G companies, the nature of their businesses varied considerably such that there were compelling reasons why each could consider different peer groups. In some cases, however, the most compelling peer group was not the one actually used.
  • Longer performance periods may see less difference between TSR results across the various peer groups as cyclical fluctuations are worked through
  • Dual peer groups (e.g. ASX 100 and ASX 200 Energy companies) will result in less volatile vesting outcomes, as there is more probability that at least one tranche will vest most years)

Credit Suisse had some excellent suggestions for questions investors could ask companies during engagement meetings. Hence O&G company directors would do well to prepare for the following questions:

  • What considerations are taken into account in constructing or selecting comparator groups? In preparing a response, chairmen should look at the follow up question below.
  • To what extent does the board feel executives have control of factors determining their ‘at risk’ executive pay? The Credit Suisse report made an assessment of the extent to which performance measures in each company can be influenced by management, and thereby serve as a more effective means of focussing management attention. Only 3 of the 9 companies had all their measures meet this criterion. The implication is that the other 6 were probably wasting shareholders’ money on ineffective incentive plans.
  • How has the remuneration committee structured executive compensation to ensure that strong performance is appropriately incentivised during periods of low and high oil prices? This will be tough to answer for many chairmen. For example, one company received a high “no” vote on its remuneration report because it paid a short-term incentive on controllable factors after the oil price (and consequently the company’s share price) went south. Other companies will be in the unenviable position of doing well on relative TSR against O&G companies but their absolute TSR will still be negative. In both cases the incentives and their measures got management attention and performance, but the resulting reward will still make many shareholders unhappy.
  • How will organisational change be reflected in executive compensation arrangements? The Credit Suisse report highlighted companies transitioning from exploration and development to production. There are good answers available to O&G companies, if they have put in place the appropriate incentive plans.
  • How is the target range for financial performance measures determined in light of potential oil price fluctuations? Credit Suisse was getting to the fact that some companies had set high performance requirements (e.g. in terms of absolute TSR or EPS growth performance) that did not meet the reality of plunging oil prices. Unfortunately, while Credit Suisse gets this, we have observed far too often that when boards respond appropriately with more realistic targets (remember the impact of the GFC anyone?), it takes a while for many investors to accept and support these new targets.

The Credit Suisse report is not available on-line, but you can email Sandra McCullagh and request a copy HERE 

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