Measuring company performance: are Middle Order Management fooling us?
This Blog will require you to shake off some of those post New Year’s celebration cobwebs, so buckle up!
There is a very well-known measure of company performance entitled Total Shareholder Returns or ‘TSR’ for short. This measure is so popular that it is used in:
- Just over 80% of FTSE 100 companies, typically measured relative to other, similar companies’ TSR.
- Just under 80% of companies in the FTSE 250
- 85% of FTSE SmallCap companies
- Roughly 70% of AIM listed companies
- 70% of the largest 250 US companies
Its use is taken for granted by Governments (the UK Government’s Directors’ Remuneration Reporting Regulations which came into force on 1 October 2013) and by Proxy Voting Agencies.
It is the ‘go to’ measure used by investors to decide whether a management team deserves praise, plaudits, or punishment.
The trouble is, it may be giving us all a ‘false reading’.
TSR measures the sum total of what a stock has returned to those who invested in it. It is a measure of the movement - upwards or downwards – of value, expressed as a percentage (%) taking into account capital gains, and the (reinvested) dividends [possibly special distributions, stock splits, and warrants]. In simple terms, that is:
- [(Current price - purchase price) + dividends] ÷ purchase price
- It is a measure of the RATE of returns
It is a popular because it gives a clear picture, over the long-term, of the overall financial benefits generated for those holding the stock.
But TSR doesn’t measure the absolute size of an investment or its return, so it tends to flatter smaller, even insignificant, investments with high rates of return over the big-ticket investments which will really move the needle.
A far less well-known measure of performance is Total Value Added (‘TVA’). That is a measure of the total amounts delivered to all of the investors by way of gains, dividends, share buybacks and so forth. It is, in effect, a measure of the SIZE of returns.
One way to think about it is if there are two enterprises of vastly different sizes, setting off to reach the same destination. You might think of them as enterprises delivering value to their investors, or you might think of them as boats leaving harbour, heading to a port called ‘Upper Quartile TSR’. If the small pleasure craft and the gigantic container vessel are travelling at the same speed they will achieve the UQ TSR port at the same time. The small vessel may even get there a few hours earlier.
In the world we inhabit today, the small vessel gets the plaudits. Higher TSR! Terrific.
But wait. The container ship is now offloading literally tons more value.
Why does this matter? Because the reality is that small companies strain to keep their executive pay ‘competitive’ by comparing their TSR (and their pay opportunity) with other, far larger, companies, where the role of ‘captain’ is in a different league.
Moving a large enterprise is a much tougher job than moving a small one, and has vastly more significant consequences. That’s why measuring TVA is at least as important an indicator of success as TSR.
We can prove this because we have used TVA in our CEO Value Index since 2012. It demonstrates that mid-sized organisations deliver far less value-for-money (paid to the CEO) than larger organisations – despite what you may have read in the financial press. The truth is that financial journalists are far more inclined to write a story about a CEO with a headline grabbing pay package than a CEO in a smaller firm paid less, despite the fact that – in relation to the sums delivered to investors, and the scale of the challenge - the BigCo CEO may deserve more and the SmallCo CEO will almost undoubtedly deserve less.
Data for the 2022 CEO Value Index data shows this:
Total Value Added delivered by the Top 20 companies in the UK is 7 times greater than that delivered by the Mid-20 companies (the 20 companies in the FTSE 350 from 101 to 127 excluding Trusts etc).
The CEO Remuneration for those same Top 20 companies is 2.5x their smaller Mid-2- counterparts
The CEO Value Index for the Top-20 is on average 4 times that of the Mid-20 companies
To be clear, that means the CEO of a larger company is delivering four times the value-for-money paid in realised remuneration compared with others… but will find their unusual pay package featured in the Sunday papers, nevertheless. If we gave Total Value Added the prominence of TSR, perhaps there would be more attention paid to those pesky smaller sized companies.
 Source: KornFerry FTSE All-Share Directors Pay Guide 2022/23; Deloitte 2022 Directors Remuneration in FTSE 100 Companies; KPMG Executive Remuneration in AIM listed companies 2021; FW Cook Global Top 250 Compensation Survey 2021/22; Remuneration Associates Limited Analysis
 “The Large and Medium-sized Companies and Groups (Accounts and Reports)(Amendment)Regulations 2013”