rTSR: When Do Relative Performance Metrics Capture Relative Performance?

Paul  Ma; Jee-Eun  Shin; Charles C. Y. Wang

Working Paper | HBS Working Paper Series | 2019

rTSR: When Do Relative Performance Metrics Capture Relative Performance?

by Paul Ma, Jee-Eun Shin and Charles C. Y. Wang

Abstract

We develop a measurement-error framework for assessing the quality of relative-performance metrics designed to filter out the systematic component of performance and analyze relative total shareholder return (rTSR)—the predominant metric market participants use to isolate managers' idiosyncratic performance—chosen by boards to evaluate managers. Among firms that explicitly use rTSR in relative performance contracts, 60%—those that choose specific peers—select rTSR metrics that do a remarkable job of filtering out the systematic component of returns in adherence to the informativeness principle. Firms that choose index-based benchmarks retain substantial systematic noise in their rTSR metrics. The choice of noisy benchmarks is associated with compensation consultants' preferences, which are uncorrelated with observable firm attributes. Firms with weak governance are more likely to choose indexes, not because of opportunism, but because they do not adequately scrutinize outside experts' advice. These findings provide novel evidence on why some executives are evaluated on systematic noise and on compensation consultants' impact on firms.

Keywords: Relative TSR; Relative performance evaluation; systematic risk; board of directors; Compensation Consultants; style effects; Executive Compensation; Performance Evaluation; Corporate Governance;

Language: English

Format: Print

58 pages

SSRN Read Now

Citation:

Ma, Paul, Jee-Eun Shin, and Charles C. Y. Wang. "rTSR: When Do Relative Performance Metrics Capture Relative Performance?" Harvard Business School Working Paper, No. 19-112, April 2019. (Revised September 2019.)

The case discusses the strategy of CIAM, a French activist investment firm, involved in a case of a buy-out of minority shareholders in the telecommunications sector. Altice NV, an international telecommunications company based in the Netherlands that owned more than 77% of SFR Group shares, made a bid for the remaining shares of France’s second largest mobile operator. Believing that the offer was woefully inadequate and constituted an abuse of power, CIAM had been fighting for a better offer as one of SFR’s vocal minority shareholders with a series of action plans—leveraging legal, communications, and public relations tactics. CIAM had just received a new piece of information, divulging a potential misuse of SFR corporate assets by Altice, and was discussing next steps.

After decades of deprioritizing shareholders' economic interests and low corporate profitability, Japan introduced the JPX-Nikkei400 in 2014. The index highlighted the country's "best-run" companies by annually selecting the 400 most profitable of its large and liquid firms. We find that managers competed for inclusion in the index by significantly increasing ROE, and they did so at least in part due to their reputational or status concerns. The ROE increase was predominantly driven by improvements in margins, which were in turn partially driven by cutting R&D intensity. Our findings suggest that indexes can affect managerial behavior through reputational or status incentives.

In October 2016, Tesla asked its shareholders to ratify their $2.4 billion bid for SolarCity. Tesla had announced a series of large projects in the preceding months including the unveiling of the Model 3, the new Solar Roof, and pushing forward the opening of the Gigafactory. All of these projects required high upfront costs. Investors were left questioning the motives behind the acquisition of SolarCity, and the reality of approving the merger.

Faculty & Research

rTSR: When Do Relative Performance Metrics Capture Relative Performance?

Abstract

Citation:

About the Author

More from the Author