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

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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.)

Using a novel dataset that comprehensively classifies the quantitative financial disclosures in firms' 10-Ks, including those hidden in the footnotes and the MD&A, we show that disclosures of non-operating and less persistent income-statement items are both frequent and economically significant, and increasingly so over time. Adjusting GAAP earnings to exclude these items creates a measure of core earnings that is highly persistent and that forecasts future performance. Street earnings for firms that meet or just beat analyst expectations are more likely to selectively exclude these items. Analysts and market participants also are slow to impound the implications of these items. Trading strategies that exploit cross-sectional differences in firms' transitory earnings produce abnormal returns of 7% to 10% per year.

Case | HBS Case Collection | March 2018 (Revised September 2019)

China Vanke: Battle for Control (A)

Lynn S. Paine, Charles C.Y. Wang, Dawn H. Lau and Anthony K. Woo

In June 2016, the board of China Vanke, one of China’s largest and best-known private residential real estate developers, must vote on a proposed acquisition that is opposed by its largest shareholders, state-owned China Resources Co. and the lesser-known property developer and financial services company Baoneng. The case describes how Baoneng amassed enough shares in Vanke to become its largest shareholder, displacing China Resources in that position. In response to Baoneng’s unwelcome advance and in support of its “railway plus property” strategy, Vanke’s management has proposed the acquisition of a unit of Shenzhen Metro, the government-owned operator of Shenzhen’s underground subway. The proposed acquisition, to be financed by issuing shares, will make Shenzhen Metro Vanke’s largest shareholder and dilute the holdings of both China Resources and Baoneng. China Resources has publicly expressed misgivings about the transaction and the board’s handling of its announcement. With three out of the 11 board seats occupied by China Resources affiliates, and a two-thirds majority needed for the proposal to pass, the vote would determine the future of Vanke.

Keywords: China Vanke; China Resources; Hostile takeover; board of directors; shareholding structure; shareholder rights; asset restructuring; Corporate Governance; Governing and Advisory Boards; Valuation; Business and Shareholder Relations; Real Estate Industry; China;

Citation:

Paine, Lynn S., Charles C.Y. Wang, Dawn H. Lau, and Anthony K. Woo. "China Vanke: Battle for Control (A)." Harvard Business School Case 318-117, March 2018. (Revised September 2019.) View Details

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This case centers around Qualcomm shareholders' 2012 Say-on-Pay vote and the dispute between the Institutional Shareholder Services and management regarding the appropriateness of the CEO's compensation plan. Was ISS right that Qualcomm's CEO's pay was inflated and justified by benchmarking to aspirational peers? Or was management correct that its CEO's pay is warranted by Qualcomm's recent firm performance?

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rTSR: When Do Relative Performance Metrics Capture Relative Performance?

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