A RENEWED FOCUS ON PERFORMANCE AMIDST INCREASED MARKET VOLATILITY

We are already seeing that performance has once again take centre stage in terms of corporate objectives in 2025.   Many organisations have adjusted their operating models coming through the pandemic and with the return to office debate still somewhat in limbo, the expectation from shareholders is that value creation returns in earnest to the agenda.  Whereas in prior years many more organisations used elements of board discretion and instruments like restricted shares more widely to manage increased market turbulence, we are seeing a return to pay for performance.

For listed companies, shareholder value creation is almost exclusively measured using Total Shareholder Return (TSR) which assesses total value created over a period of time regardless of whether it is distributed in terms of share price appreciation, dividends or any other mechanism.  Most companies measure TSR on a relative basis against a basket of peers.  Some organisations take a broad slice of the whole market, like for example the FTSE 250, and some use a select group of industry peers.  With the focus being firmly back on performance and pay for performance, getting the basis of comparison right is imperative.  This has become even more difficult, and at the same time important, given the increase in market volatility we’ve seen this year as a result of geopolitical and other trade related tensions.  Here we provide three key insights, based on our extensive performance and reward consulting research and experience, to help define the peer group for any organisation using TSR as one of the performance metrics in the design of Long-Term Incentive Plans within its Executive Compensation Strategy (Exhibit 1).

Exhibit 1. Executive Pay: The Right TSR Peers Drive LTIP Success.

Size Matters

Adding 10% in market value to a business with a market capitalisation of $100 million is not the same thing as adding 10% to a market capitalisation of $1 Billion.  Peers should be, on order of magnitude at least, similar to your company in size.  Organisations that are part of a constituent index, like the FTSE 250, who then use the same index for TSR, get this one right as part of that process.  Where similar industry peers are chosen, additional care must be used.

Understand Business Risk

Business risk is the main driver of share price volatility, where the changes in a single share price relative to the market are concerned.  A business risk analysis allows companies to choose peers that will be expected to move in a similar way relative to the market over time, allowing a true out or under performance by the company to be measured and rewarded.  The drivers of business risk are primarily two:

1.     Revenue Volatility – how volatile are revenues in the industry and what are the main risk factors that we are exposed to.

2.     Operating Leverage – the ratio of fixed to variable costs in the business i.e. if revenues are different to expectations, how quickly can we readjust the cost base to compensate or capitalise.

In some industries, picking a peer group is relatively easy and intuitive.  In others it may not be that easy, or alternatively, there might not be enough obvious pure play peers.  In instances like these we often see companies going for a broad index like the FTSE 250.  Where your business has a lower or higher intrinsic business risk than the market, measuring TSR on a relative basis will unfortunately depend less on company performance and more on whether the overall market outperforms or underperforms.

Businesses with lower business risk will outperform in a market downturn (bear market) and businesses with a higher business risk will outperform in a rising market (bull market) and vice versa.  In the Exhibit 2, we have grouped some of the main industries into low, at market and high business risk.  As can be seen, retail is not just retail.  Beverages will be different depending on the contents of the can or bottle.  A Fintech business might be more difficult to gauge as traditional financial services and technology are still quite far apart in terms of business risk.

Our Reward Consultancy can measure your unique level of business risk with a bespoke business risk index calculation to guide better decision making in this area.

Exhibit 2. Selected Industries by Business Risk Index Value.

Look To The Future

The final consideration when selecting or reviewing your TSR peer group is to look at what future growth might look like.  For some organisations much of today’s market value is already derived from current operations.  For others, it’s the expected future growth value that is the key element.  Organisations and industries with higher future growth value expectations will likely outperform those more mature industry and sub-industry segments where expectations are lower.  Recent work in alcoholic beverages for example highlights the difference between brewers and distillers – organisations that many might normally see as being comparable and good TSR industry peers.

Given the markedly increased equity market volatility that we have seen in 2025 along with a renewed focus on performance and pay for performance amongst shareholders, selecting the correct peer group for total shareholder and other return based calculations has become more important than ever.  The approach outlined above as developed by our reward consultants is a step forward that organisations should consider.

Paul Hunter, Principal Consultant at People. Performance. Reward.

paul@people-performance-reward.co.uk