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Total Shareholder Return: Planning a Future Perfect

Total shareholder return can not only be a measure of past performance, but it can be harnessed as the prime touchstone for planning future performance.

Fortnightly Magazine - January 2006

described here provides in your projection today, based on the best information available today. Part of the planning process, of course, is to keep that projection updated with some regularity and to make whatever corresponding adjustments are called for by your TSR aspirations. 3

Another point is that one cannot predict exactly when the market is going to swing into alignment with the calculated value perspective. Some of the plans that underpin that valuation may take time to roll out. The market might not be convinced that a plan will work until it starts to see results.

And, of course, some plans simply may not work. What the series of calculations described above tells us is the TSR that is embedded in the plan. Whether that TSR matches the TSR that ultimately occurs is just as dependent as any other forecast on the quality of the plan and its execution.

Managing to TSR

The question then becomes, how do we manage to this long-term goal? How can we translate TSR into an actionable basis for performance management?

The answer is, indirectly. TSR should not be a direct management measure. For reasons discussed earlier, TSR in the short run is highly misleading. Even the best-run companies will place in the first quartile among peers in some years and second or even third in other years. (And some of the worst-run companies may find themselves in the top quartile in a given year owning to a rebound from some slip-up.)

Over time, superior companies doubtless will be among the top TSR performers, but from year to year their quartile rankings will, indeed must, shift. Instead of a yearly TSR goal then, we suggest a 5-year TSR goal, based on achieving a long-term targeted TSR level. That level may be set with the intention of placing the company over that extended period in the top quartile of shareholder return, but management should not be evaluated on whether the target is reached during any shorter segment of that period.

A long-term TSR target is meant to encourage management to think in the long term, and to focus on the issues it is able actually to manage rather than casting a nervous eye continually over its shoulder at how the market is reacting on any given day, quarter, or even year.

So TSR should be a long-run goal. The metrics of performance management, on the other hand, must operate in the short run. A company can’t wait five years to take a reading on how well management is performing. In this respect, TSR works powerfully, but indirectly.

Recall from the TSR projection illustrated above that in the sequence of calculations that determines long-term TSR the only real variable under management control is the plan— shown in the chart as “value of plan above market.” The short-term evidence of how well management is performing toward meeting its long-term goal is whether it’s making plans that will put it on the right TSR trajectory, and whether it’s accomplishing the substance of those plans.

Management therefore should be asked two