Performance Shares

Definition

Performance shares are a form of equity compensation given to executives that are contingent on the company meeting certain performance criteria over a specified period. These shares align the interests of executives with those of shareholders, as their value is directly tied to the company's performance metrics, such as earnings per share or total shareholder return. This mechanism encourages executives to focus on long-term value creation, ensuring that their compensation reflects the company's success.

5 Must Know Facts For Your Next Test

1. Performance shares are usually granted based on a multi-year performance cycle, allowing companies to assess long-term results rather than short-term fluctuations.
2. The criteria for earning performance shares can vary widely and may include measures like revenue growth, profitability, or market share increases.
3. If performance targets are met, executives receive shares; if not, they may receive no shares or fewer shares than expected, emphasizing accountability.
4. This type of compensation is intended to reduce the risk of short-term decision-making and encourage actions that benefit the company over a longer horizon.
5. Performance shares have become increasingly popular in executive compensation packages as shareholders seek alignment between management pay and company performance.

Review Questions

• How do performance shares impact executive decision-making within a company?
  • Performance shares motivate executives to focus on achieving specific long-term performance goals rather than making short-term decisions that could be detrimental to the company's future. By linking compensation directly to metrics like earnings growth or shareholder returns, executives are encouraged to adopt strategies that enhance overall company performance over time. This alignment of interests helps ensure that management actions are in the best interest of shareholders.
• Compare and contrast performance shares with traditional stock options in terms of risk and reward for executives.
  • While both performance shares and stock options aim to align executive incentives with shareholder interests, they differ significantly in risk and reward structures. Performance shares require the company to meet specific performance targets before they can be earned, creating a direct link between executive actions and outcomes. In contrast, stock options provide executives the right to purchase shares at a set price regardless of performance, which may lead to less accountability. This makes performance shares generally more tied to actual company success.
• Evaluate the effectiveness of performance shares as a tool for enhancing corporate governance and reducing agency costs.
  • Performance shares can be highly effective in enhancing corporate governance by aligning executive interests with those of shareholders, thereby reducing agency costs associated with conflicting goals. By tying compensation to clear performance metrics, these instruments promote transparency and accountability among executives. However, their effectiveness depends on carefully selecting appropriate performance measures and ensuring that these align with long-term strategic objectives. If designed poorly, they could incentivize undesirable behaviors or short-term thinking, undermining their intended purpose.

Related terms

Equity Compensation: A method of rewarding employees, typically executives, with shares or stock options in the company as part of their compensation package.

Stock Options: A financial incentive that gives executives the right to purchase company stock at a predetermined price after a certain period.

Incentive Plans: Programs designed to motivate employees by offering rewards based on achieving specific performance targets.