Return on Capital a Better Metric Than Total Shareholder Return, Says New York Times Study

June 24, 2016

The New York Times weighed in last week on how companies should link executive pay and performance, releasing a new study casting doubt on the effectiveness of total shareholder return (TSR) as a performance metric and touting the use of an alternative metric, yet failing to acknowledge that no one single metric should be relied upon to measure all companies in all situations.  Many companies have expressed concern that because proxy advisory firms and investors use TSR to look at company performance, company incentive metrics have become too focused on that metric.  Yet, in commenting about metrics used, New York Times columnist Gretchen Morgenson, who requested the study, seemed to suggest homogenization was desirable as long as the correct metric is used, stating that metrics vary "even within the same industry, making apples-to-apples comparisons difficult."   The Times' study suggested that companies should determine pay based on return on capital over five years relative to their industry.  Even though the study's authors in the past have admitted that "there is no single, silver bullet performance measure" for all companies, the study targets executives who are "overpaid" based on a comparison of relative pay to relative return on capital, stating it is "the only real foundation there is for investment value, and for national prosperity."  While return metrics are an important indicator of whether a company is making good use of capital, good performance may be contextual, depending on the industry for example, where a company is in its growth cycle.  As several of the companies targeted by the study pointed out, a company in a growth strategy may not achieve a return on capital exceeding its peers at a given point in its strategic timeline, but the investments made in entering or growing in a particular market will have great benefit for shareholders in the longer term.  As with so many aspects of executive compensation and governance, the Board is in the best position to determine what the drivers of long-term growth are for the company and those should be effectively communicated to shareholders.  For most companies, this will involve a combination of metrics that inform the company's strategy at a given moment in time (the preferred approach of most sophisticated investors), rather than reliance on any single metric, however powerful.