Performance shares

Definition

Performance shares are a form of equity compensation awarded to executives and employees based on the achievement of specific performance targets over a set period. These shares align the interests of the executives with those of the company's shareholders, as they typically vest only when predetermined performance metrics, such as earnings growth or total shareholder return, are met. This type of compensation encourages executives to focus on long-term value creation and aligns their goals with the overall financial health of the company.

5 Must Know Facts For Your Next Test

1. Performance shares are often tied to specific financial metrics such as revenue growth, EBITDA margins, or market share increases over a multi-year period.
2. They are designed to motivate executives by directly linking their compensation to the company's performance, thus fostering a focus on achieving business goals.
3. The granting of performance shares typically occurs as part of an annual compensation package and may vary based on individual performance and company results.
4. Upon meeting performance goals, executives receive actual shares of stock, which can then be sold for cash or retained as an investment in the company.
5. Performance shares may have a longer vesting period compared to traditional stock options, ensuring that executives remain focused on sustained long-term performance rather than short-term gains.

Review Questions

• How do performance shares serve to align executive compensation with shareholder interests?
  • Performance shares align executive compensation with shareholder interests by tying rewards directly to the achievement of specific financial performance targets. By making these shares contingent on meeting criteria such as earnings growth or total shareholder return, executives are incentivized to focus on strategies that drive long-term value creation. This structure promotes accountability among executives, ensuring their decisions reflect the best interests of shareholders.
• Discuss the impact of performance shares on executive behavior and company culture.
  • The introduction of performance shares can significantly impact executive behavior and company culture by fostering a results-oriented environment. Executives motivated by the potential for higher compensation linked to performance metrics are more likely to pursue strategic initiatives that enhance company value. This approach can cultivate a culture where long-term planning and accountability are prioritized, encouraging collaboration among leadership teams to achieve common financial goals.
• Evaluate how effectively structured performance share plans can mitigate risks related to excessive risk-taking by executives.
  • Effectively structured performance share plans can mitigate risks associated with excessive risk-taking by ensuring that the performance metrics are comprehensive and balanced. By including various metrics that assess both short-term and long-term performance outcomes, companies can discourage executives from pursuing aggressive strategies that could jeopardize the company's future stability. Additionally, incorporating measures like relative total shareholder return can help align executives' interests with those of shareholders while minimizing the temptation to take undue risks for immediate gains.

Related terms

Equity compensation: A non-cash pay that represents ownership in the company, often provided in the form of stock options or shares.

Vesting schedule: A timeline that outlines when an employee earns the right to own their granted shares or options, usually contingent upon continued employment or performance.

Total shareholder return (TSR): A performance metric that measures the total return of an investment in a company’s stock over a specific period, accounting for price appreciation and dividends.