Everything’s Relative – Just Why Does It Have To Be TSR!?
06/03/2006
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This is the second newsletter in a row in which we have a knock at relative TSR.  Please do not get us wrong.  It is an excellent measure to apply for determining performance and allocating performance pay to top executives in a large proportion of cases.  And we are not just saying that because the very first companies in Australia to apply this did so on the advice of one of our directors (but what can we say – he was younger then).  And let’s face facts.  In a world that is in danger of becoming too “tick the box” prescriptive, it is the favourite performance measure for some governance and proxy groups. 

So the reality for many companies is that there is no choice but relative TSR as a performance measure.  But what escapes some boards and their advisers is that there is more than one variety of relative TSR.  For example, if you are a big company in a small sector how fair is it that TSR performance be measured against mostly much smaller, more nimble and more volatile companies?  Your relative TSR performance will never be near the top, and will more often be near the bottom.  This is fact.  Our statistical analyses and performance probabilities tell us this every time we encounter it.  Relative TSR applied in the traditional way in these cases is both unfair and inappropriate.  It would fail the basic test to attract, retain and motivate your executives.

It does not have to be like this.  Reject the traditional way.  Index it.  That is, create an index that weights TSR by market capitalisation (easy to do – or there may be an already made S&P one handy).  Or rank order the TSR weighted by market capitalisation (i.e. in dollar terms, rather than percentages).  Much fairer for the CEO of a big company that, for want of any other choices, has to be compared against the tiddlers. 

And it is still relative TSR.  Long (sigh) may it live.  And there are more alternatives than these two that are still, in effect, relative.  More in later newsletters.

© Guerdon Associates 2021
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