Total Shareholder Return: A common performance metric for share incentives

Whether you are overseeing your company’s Long-Term Incentive Plan, participating in your company’s incentives, or engaged in the financial accounting and reporting of these plans, you’ve likely encountered the abbreviation “TSR” – total shareholder return. But what exactly is TSR?

Total Shareholder Return basics

Investors who hold shares expect returns on their investments through share price growth, as well as cash dividends as a share of company profits. Since dividends are distributed to shareholders, the share price – representing shareholders’ equity in the business – typically drops by the amount of the dividend when it’s announced. Consequently, a company that consistently pays higher dividends, annually, might not be directly comparable to a company with minimal dividend payouts in terms of share price growth alone.

TSR addresses this shortcoming, by calculating the overall return an investor has generated from owning a company’s stock, taking into account both stock price changes and dividends distributed to shareholders. Broadly speaking, TSR quantifies the total success or return on investment over a specific timeframe, factoring in dividends received and reinvested during that period. The reinvestment of dividends is the primary factor distinguishing TSR from mere share price growth.

Relevance to Employee Share Incentives

Share incentive plans often incorporate performance conditions that need to be met to maximise the incentive. These conditions encompass various internal financial targets within the company, such as achieving profit objectives, or, in some cases, targets related to stock market performance (i.e., share price performance). By integrating performance metrics into employee incentives, businesses can align compensation with the company’s goals and long-term success, particularly for executives and managers who drive shareholder growth.

Total Shareholder Return (TSR)-based performance conditions for share incentives are gaining popularity globally. They work as a measure to track how a company’s equity is growing. When the equity value grows, it means more value not just for shareholders but also for employees who have an indirect interest in the company’s success. Furthermore, TSR enables companies to compare their equity growth against peers in the industry. In some cases, evaluating relative equity performance against a group of peers may be more valuable than solely focusing on the absolute increase in equity value, given the inherent volatility of stock markets.

Also read: “Valuing complex share incentive using the Monte Carlo Method

Navigating Total Shareholder Return complexities

TSR is commonly applied to performance-based share incentives, and as such, plan administrators should be aware of the various intricacies involved in its calculation.

  • Correct time periods: Ensure consistent starting and ending dates when measuring stock price changes and dividend payments.
  • Dividends: When dividends are reinvested, they should be factored in (on the ex-dividend date) using the precise dividend payment dates and yields.
  • Stock splits and mergers: Adjusting for events like these is essential as they can impact the number of shares in issue and the stock price.
  • Currency conversion: Accurate currency conversions are necessary when dealing with stocks listed in different currencies.
  • Negative returns: Negative stock price changes should be included rather than omitted.
  • Cumulative vs. annualised TSR: Clearly distinguish between cumulative TSR over the entire period and annualised average return over the period, as the formulas differ.
  • Geometric mean: TSR uses the geometric mean formula to account for compounding effects rather than an arithmetic mean.
  • Benchmark comparisons: Comparing a company’s TSR to a benchmark or index adds context, but using the wrong benchmark can lead to misleading results.

In conclusion, TSR is a comprehensive metric for assessing the overall return of a share, aligning employee incentives with company objectives, and measuring equity growth. Though its calculation does involve complexities, grasping and addressing these intricacies is essential for precise and valuable TSR assessments. If uncertain, seeking advice from financial professionals or utilising trustworthy financial software can assist in ensuring accurate TSR calculations.

Read why TSR is “A Better Way to Assess Managerial Performance

How can ShareForce help?

Discover a simplified solution for valuing and understanding TSR conditions with the ShareForce platform. Easily track TSR performance, run valuations, and get instant results for both administrators and employees alike. With ShareForce’s user-friendly administration portal, replicating TSR conditions and calculating fair values has never been easier. Conduct TSR calculations at any stage of your share incentive plan, from issuance to vesting. Explore the platform’s capability to test scenarios and evaluate the impact of altering performance metrics or inputs. Unleash the power of ShareForce to design future incentive plans and more.

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