Is Paying for TSR Paying for Performance? Observations on the the SEC's Proposed Rules

This paper highlights the strengths and weaknesses of the U.S. Securities & Exchange Commission’s (SEC’s) proposed rules on disclosure of pay versus performance, makes several suggestions to improve the proposed rules, presents some surprising data showing that CEO pay is much more highly correlated with gross TSR than relative TSR, explains the importance of “industry beta” in making relative TSR an accurate measure of management performance and shows that for companies with negative industry betas – about one company in six – paying for TSR is paying for management performance. The key weakness of the proposed rules is that the SEC’s interpretation of “compensation actually paid” – the statutory language – undermines the matching of pay and performance periods and makes pay for performance look much worse than it really is. Our key suggestion for improvement is an alternative interpretation that does match pay and performance periods. The paper concludes with a discussion of the comment letter writers who criticize the SEC’s use of TSR as a measure of management performance. They identify the right problem – factors beyond management control – but make unpersuasive arguments for using operating measures instead of relative TSR taking account of industry beta.