Study of Performance Share Units (PSUs) sees higher pay, lower performance

Performance Share Units (PSUs), otherwise known as Performance Rights in Australia, are contingent on performance against set metrics.

Investor and proxy adviser demand for restraint on CEO pay and for pay to be linked to performance has contributed to an increase in PSU use. Yet a recent research study soon to be published by our GECN Group’s US based colleague Marc Hodak and the MIT Sloan School of Management casts doubt on their utility. Their work finds that S&P 1500 companies that award PSUs see lower relative total shareholder return (TSR) yet higher compensation, compared to those which award Restricted Share Units (RSUs) and stock options.

Complexity

Traditional equity compensation in the form of RSUs or stock options tends to be straightforward. They vest over time, provided the executive stays with the company. These forms of equity directly link executives’ personal wealth to share price movements, creating a clear and sustainable alignment with shareholders.

In contrast, PSUs introduce complexity. Companies must decide what performance metrics to use (e.g., earnings, revenue growth, or return on capital, etc.), and which mix of financial, market-based, and non-financial measures. They must also establish a scale for each metric that determines how many shares vest at different levels of achievement, meaning setting valid long-term executive remuneration performance targets has become an even greater challenge. (For a discussion regarding assessing executive remuneration in uncertain times, see HERE).

Do PSUs drive performance?

Overall Marc and his MIT Sloan co-authors find that from 2010 to 2022 those with PSUs had negative three-year TSR performance relative to sector peers. In contrast it was positive for those without PSUs.

Higher costs without higher returns

The research also found that PSUs are associated with higher equity grant values across all years from 2010 to 2022. As PSUs are perceived to be more at risk than RSUs because performance is subject to variable factors, executives demand higher potential rewards since, naturally, higher risk requires higher reward to compensate. This goes against an investor and proxy adviser expectation that the use of PSUs would limit the growth in CEO pay.

Should we get rid of PSUs?

While pay-for-performance remains the focus, this research indicates that PSUs may not be the best fit in all cases, especially in dynamic industries or where performance metrics are hard to define. Simpler service based equity grants may offer clearer, more effective incentives.

Alas, without a broader re-evaluation from major institutional investors, the trend toward PSUs is unlikely to reverse despite the evidence of rising costs and mixed results. At least, a more nuanced approach to incentive design may be warranted.

Ultimately, the goal of an incentive structure should be one that is transparent, cost-effective, and truly aligned with shareholder value.

A recent Guerdon Associates article can provide an idea of whether RSUs could be a fit for your company. To read this article, click HERE.

Last month’s newsletter contained an article detailing the prevalence of RSUs in the ASX100, which can be found HERE.

To read the our sister US firm’s summary, including charts of year on year change in the S&P 1500, click HERE.