The Evolution of Total Shareholder Return and Incentive Plans: Boards are guiding companies away from one-size-fits-all solutions and toward a tailored mix of incentives.

• Author: Delves, Don

In 2011, when the SEC first required companies to hold a nonbinding vote on executive pay (affectionately known as "say on pay"), there was a rush by companies to adopt long-term incentive plans tied to their total shareholder return relative to other companies (RTSR). These plans were considered safe and virtually unassailable by proxy advisors and investors. Roughly 50 to 60% of U.S. public companies (the percentage varies by industry and size of company, with larger companies more likely to use RTSR) adopted such plans by 2015 and, in most cases, RTSR was the only performance measure used to determine how many performance shares would be earned, typically over a three-year period.

At the time, Willis Towers Watson published an article in Directors & Boards stating our concerns with the preponderance of these plans and the resulting homogeneity of incentive design. Among our concerns about the heavy use of RTSR were the following:

* Weak line of sight and motivational value. A company's RTSR is a result of its actions and financial performance and is significantly influenced by market factors beyond the control of the executive team. For most executives, RTSR does not provide clear direction to take specific actions, drive key performance goals, hit milestones and achieve results.

* No tie to strategy or key value drivers. This is similar to the prior point, but, again, RTSR is a result. Our research and experience shows that high-performing companies tie their annual and long-term incentives to achievement of strategic goals and consistent improvement of a core set of key value drivers over time.

* Possibility of pay for poor performance. Many of the early RTSR plans paid strictly for relative performance. Hence, the company could have significant negative TSR but still beat its peers and earn a payout. We note that many companies have modified their plans over the years to eliminate this possibility by requiring a threshold level of absolute TSR (ATSR) that must be achieved.

* May not reflect sustained long-term value creation. Given the end-to-end calculation of TSR (based on the beginning and ending of a three-year period), it can be argued that TSR plans reflect a company's performance and value at a moment in time and may not capture sustained performance and value creation over the long term.

In the years since 2011, companies and their boards have gained a great deal of experience with RTSR plans. While 62% of the S&P 500...