What to do about Performance Anxiety?

Relative Total Shareholder Return (TSR) measures have become ubiquitous in Long-term Incentives (LTI). Has their use moved from rewarding executive outperformance to reflecting company contribution to fund managers’ performance?

If TSR were to be used as an objective and valid measure of executive performance, one would be forgiven for thinking a company’s TSR would be compared to the TSR of direct competitors, subject to similar cyclical and other headwinds and tail winds. But you would be wrong.

Most (77) ASX 100 companies with an LTI utilise a relative TSR measure. Only 16 companies forego relative TSR as an LTI measure.

Of the 77 companies which do utilise a relative TSR measure, 58 compare performance to an index-based peer group.

Only 19 companies use a bespoke peer group of carefully selected peers. Six companies have index peer groups and bespoke groups. Table 1 provides a summary of relative TSR comparator groups.

Table 1: ASX 100 Relative TSR Comparator Group Summary (n=100)

 

Of the companies with an index-based comparator group, 28 use a broad-based index without exclusions (e.g. the ASX 200), 16 use a broad-based index with exclusions (generally based on sector, e.g., ASX 200 excluding Real Estate), and 18 use a sector-based index (e.g., the S&P Global Mining Index). Table 2 provides a summary of relative TSR Index-based comparator groups.

Table 2: ASX 100 Relative TSR Index-based Comparator Group Summary

 

Company categories frequently excluded from broad-based indices are noted below.

Table 3: ASX 100 Relative TSR Comparator Group Exclusions (some peer groups exclude more than 1)

 

Relative TSR was originally intended to compare similar companies exposed to the same external factors and measure which performed above the pack. It only works well if the companies are similar enough. If they are not, the only external factor relative TSR removes is how bullish the market is overall. But this is not very fair, as company configurations each vary in their degree of responsiveness to market sentiment.

A broad-based index peer group (such as the ASX 100) will compare growth companies to defensive companies. It will compare companies exposed to completely different drivers (e.g., an international export company exposed to US tariffs versus a purely Australian-based health insurer). While there is an element of executive performance to vesting, luck, market perceptions, and industry-specific external factors have a large part to play.

Bespoke peer groups allow the board to align outcomes with performance against true peers, and while they are not always perfect due to the shallow nature of the Australian share market, they align better to the underlying intent of relative TSR.

However, some proxy advisers and investors see bespoke peer groups as a company ‘cherry-picking’ to get the outcomes they want. Index-based peer groups are typically less controversial. And given Index-based peer groups generally only pay out if the investment beats the same kind of broad benchmark many fund managers are being measured against, one can see why.

In behavioural terms, relative TSR hurdles are often as motivational as a lottery ticket. For some, it may be time to consider moving back towards bespoke peer groups, designing better vesting schedules to accommodate smaller numbers of comparators, or defying the desire to box tick and choosing another measure.