An analysis of S&P 500 company data over a decade reveals that embedding total shareholder return (TSR) as a performance metric into executive compensation plans may not be the blanket solution for linking executive incentives with shareholder interests.

According to the research conducted by the Institute for Compensation Studies at Cornell University’s ILR School, “almost half of the 2014 S&P 500 firms offer TSR plans to their named executive officers—a twofold increase between 2004 and 2013.

While growth in the use of TSR plans is observed across all sectors, the average weight placed on TSR in the compensation plans has been falling since 2004, the starting point for the study.

“Most surprising perhaps,” states Hassan Enayati, one of the researchers on the project and lead author of the research brief, “is that the evidence from our statistical regression analysis indicates that there is either no impact of TSR plans on firm performance or weak evidence of a negative relationship.”

Funding, data and valuable insight on the structure of executive compensation were provided by Pearl Meyer, an executive compensation consultancy.

“As we suspected, the study revealed that TSR does not lead to improved company performance, and our experience as Board advisors tells us it does little to provide line of sight from management’s actions to ultimate results,” said David Swinford, President and CEO of Pearl Meyer. “However, many companies feel compelled to create an incentive program that aligns well with proxy advisory policies, which use TSR to measure pay-for-performance. Unfortunately, while this approach satisfies external pressures and conforms to market norms, it is not effective.”

In a recent opinion survey of executives and outside Directors, a significant majority—75 percent of those surveyed—said the importance of including relative TSR in an incentive plan is either somewhat or very important in response to peer practices, while 56% pointed to investor concerns and more than half (52%) cited the influence of proxy advisory groups. The same study also found that most firms do not believe TSR results accurately reflect the performance of their executive team. (Pearl Meyer On Point: Looking Ahead to Executive Pay Practices 2016, September, 2015)

Despite the expanding use of such TSR plans, the academic analysis of the link between such metrics and firm performance is limited. According to Enayati, this work not only clarifies the trends associated with expanding TSR plans for executives of S&P 500 companies, but also surfaces the “need for further empirical research on the relationship between the inclusion of TSR and other metrics of firm performance in the compensation plans of top executives and the ultimate sustainable financial success for the firms they lead.” The future steps the research team is considering is examining, for example, more refined measures of TSR awards.

In a media statement, Swinford said that “the pressure to use TSR may only become more intense with the SEC’s proposed rules to mandate disclosure of pay-for-performance through the TSR lens.”

He continued: “While TSR can be a helpful tool for rewarding executives who outperform peers and it does generally align executive and shareholder interests, it is not fundamentally an effective incentive metric.

“We understand the reasons for the popularity of TSR, but when the primary objective of an executive compensation program is to better enable strategy execution through incentives, proxy advisory policies and external pressures should be secondary considerations.”

“We believe Compensation Committees would be well served to evaluate other financial and operational measures,” Swinford concluded. “It’s our experience that the most effective incentive plan metrics reflect the company’s business model, economic cycles and any unique challenges and opportunities facing the organization; and therefore should be chosen on a company-by-company basis to ensure they provide clear alignment with the corporate strategy.”

In addition to Enayati, researchers on the broader project team included Kevin F. Hallock, Stephanie Thomas and Linda Barrington.

For full research brief, see TSR, Executive Compensation, and Firm Performance—An ICS Research Brief

Sources: Cornell University, Pearl Meyer

About Cornell University ILR School Institute for Compensation Studies

The Institute for Compensation Studies (ICS) is an interdisciplinary center housed in the ILR School of Cornell University. Its mission is to improve teaching, research, practice, and public discourse around compensation and rewards to work by bridging between academic researchers and compensation practitioners. ICS seeks to enhance understanding of how rewards to work can influence outcomes for companies, individuals, and economies.

About Pearl Meyer

Pearl Meyer is an advisor to boards and senior management on the alignment of executive compensation with business and leadership strategy, making pay programs a powerful catalyst for value creation and competitive advantage. Pearl Meyer’s global clients range from emerging high-growth, not-for-profit, and private companies to the Fortune 500 and FTSE 350.