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Performance Share Plans: Valuation and Empirical Tests

66 Pages Posted: 18 Nov 2012 Last revised: 2 Sep 2017

Craig W. Holden

Indiana University - Kelley School of Business - Department of Finance

Daniel Sungyeon Kim

Peking University HSBC Business School

Date Written: March 31, 2017

Abstract

Performance share plans are an increasingly important component of executive compensation. They are equity-based, long-term incentive plans where the number of shares to be awarded is a quasi-linear function of a performance result over a fixed time period. We derive closed-form formulas for the value of a performance share plan when the performance measure is: (1) a non-traded measure following an Arithmetic Brownian Motion (e.g., earnings per share), (2) a non-traded measure following a Geometric Brownian Motion (e.g., revenue), or (3) a rank-order tournament of traded asset returns that are following Arithmetic Brownian Motions (e.g., percentile of ranked stock returns). Then we empirically test our valuation formulas. We find that our valuation formulas are more accurate for performance share plans based on earnings per share when forecasting using analyst consensus prior to the grant date. We also find that the efficiency of our valuation model greatly depends on the method used to forecast future firm performance. The policy implication is that FASB should consider requiring that grant date fair value be estimated using valuation formulas such as ours.

Keywords: Executive compensation, Performance share plan, Performance-vested share plan

JEL Classification: G34

Suggested Citation

Holden, Craig W. and Kim, Daniel Sungyeon, Performance Share Plans: Valuation and Empirical Tests (March 31, 2017). Journal of Corporate Finance, Vol. 44, No. 99-125, 2017. Available at SSRN: https://ssrn.com/abstract=2177363 or http://dx.doi.org/10.2139/ssrn.2177363

Craig W. Holden (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

Kelley School of Business
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3383 (Phone)
812-855-5875 (Fax)

HOME PAGE: http://www.kelley.iu.edu/cholden

Daniel Sungyeon Kim

Peking University HSBC Business School ( email )

University Town
Shenzhen, Nanshan District 518055
China

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