Taking a hit in the GFC could have unfair executive pay results

Companies whose share price dropped the most during the recent GFC may see their executives receive windfall rewards if they have awarded share based remuneration contingent on relative TSR rankings.  The converse is also true.  If the share price was not adversely affected during the GFC, then relative rankings are likely to drop leaving good performance unrewarded as share price recovery occurs in peer companies.


This, and other relative TSR issues, has been raised in the past (for example, see HERE).  This article provides research evidence to illustrate the point, and concludes with suggestions for board remuneration committee consideration.


In more normal periods, there is typically a positive correlation between a company’s total shareholder return (TSR) from year to year (i.e. a company that performs well one year tends to perform well the next year).  This empirical fact supports continued use of relative TSR measures (providing an appropriate peer group can be found).  However, the TSR for S&P ASX 50 companies for calendar 2009 is negatively correlated with the TSR for calendar 2008 during the worst of the GFC (see figure 1 below).  This implies that the companies whose share price recovered the most in 2009 also lost the most in 2008.  This is a predictable and unsurprising finding.  However, the implications of this may present problems to boards when managing long term incentives (LTIs).

100705 figure 1


The bubbles represent market capitalisation.  The R squared statistic is 42%, suggesting that almost half of the 2009 TSR is directly related to the fall in TSR in 2008.


Seventy seven percent of the companies in the ASX50 use relative TSR as a LTI hurdle and more than half of these use it as their only hurdle. The graph below shows the proportion using TSR hurdles.


100701 figure 2 V2

Most commonly, no equity vests if relative TSR is below the 50th percentile and all equity vests if TSR is ranked at or above the 75th percentile.


Relative TSR works well as a hurdle in a market where share price volatility is reasonably consistent over time and a rational peer group is available.  If this is the case, TSR reflects the current profitability and the likely future performance of the company.  In June 2007 the average volatility of the current ASX 50 companies was 26%.  By June 2008 it had increased to 38% and by June 2009 it was 61%. 


The industries with the lowest volatility include consumer staple, healthcare and energy utilities.  These are the sectors that will be negatively impacted if they have made grants to executives during the worst of the GFC and in the early recovery stages, that is, between January 2009 and September 2009. Other sectors may see windfall gains in TSR if they made grants during the same period.


For illustrative purposes we show the impact on some companies’ relative TSR outcomes if their TSR were compared to other ASX50 companies, and as if they made grants before and during the GFC.  Note that this analysis is not necessarily indicative of these companies’ current or past practices.


The following table shows the negative impact on four companies (identified by industry) that were ranked relatively highly in the three years prior to the GFC.  It also shows an estimated TSR ranking for grants made early in 2009, assuming that 2010 and 2011 have annual TSR similar to the annualised three years to December 2007.

 100705 table 1 v2


The share price for these four companies did not drop significantly during 2008 and therefore did not experience a strong recovery in 2009, producing a high TSR ranking in 2008 and a low TSR ranking in 2009.  Grants made early in 2009 will start from a very high base.  If an ASX50 relative TSR is applied in their cases, they are unlikely to vest, even if previous performance levels are maintained throughout 2010 and 2011.


Conversely, Table 2 shows the positive impact on four companies when performance was relatively low in the three years prior to the GFC.  It also shows an estimated ranking for grants made early in 2009, assuming that 2010 and 2011 have annual TSR similar to the annualised TSR over the three years to December 2007.


100705 table 2 v2

The share price for these four companies dropped significantly during 2008 and recovered strongly in 2009, producing a low TSR ranking in 2008 and a high TSR ranking in 2009.  Grants made early in 2009 will start from a very low base and, if an ASX50 relative TSR measure is applied, are likely to vest, even if historical TSR levels are maintained throughout 2010 and 2011.


Note that the results for these example companies would be different if an industry specific peer group rather than the more general ASX50 peer group was used.


We can draw the following conclusions from the research:


·         Relative TSR measures unfairly penalise the management of less volatile and companies relative to the management of more volatile companies as an economy recovers from a downturn

·         A stand alone relative TSR measure for LTI may be inequitable and unfair, depending on the economic cycle and grant dates

·         A combination of absolute and relative measures may make sense to ensure equitable rewards over time (i.e. two measures are better than one)

·         If relative TSR measures are the only feasible LTI measure (e.g. in commodity based stocks where earnings are difficult to predict), then other remuneration methods should also be considered for long term shareholder alignment (e.g. encouraging share ownership over the longer term)

·         Hurdles should be reviewed carefully each year prior to grant to recognise the likely impact of economic cycles

·         Timing of grants can make a difference and should therefore be made at the same time each year to avoid accusations of opportunism


Fundamentally, boards should consider what is right for their company’s situation.  While non-binding shareholder votes and the coming two strikes regulation may be currently uppermost in many directors’ minds, we have found that the fundamental needs of the company will be supported by the great majority of shareholders with patient engagement and cogent explanation and disclosure.

© Guerdon Associates 2024
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