Montgomery Investment Technology, Inc. has been providing Total Shareholder Return (TSR) valuation services to a wide range of corporations for over twenty five years. The fair value calculations generated using Monte Carlo simulation are compliant with ASC 718 and IFRS 2.
An ASC 718 TSR valuation is a specialized financial appraisal required by U.S. GAAP (Accounting Standards Codification Topic 718) to determine the fair value of equity awards that vest based on Total Shareholder Return (TSR).
Because these awards depend on future stock price performance, often relative to a group of peer companies, they cannot be valued using simple formulas like Black-Scholes. Instead, they require complex “stochastic” modeling, typically a Monte Carlo simulation
1. Why is a special valuation needed?
Under ASC 718, TSR is classified as a Market Condition. Unlike “Performance Conditions” (such as hitting a revenue goal), market conditions must be integrated into the fair value on the grant date.
- Fixed Expense: Once the grant-date fair value is determined, the total compensation expense is fixed. Even if the TSR target is never met and zero shares are issued, the company must still record the full expense in its financial statements.
- No “True-ups”: Unlike other awards where you adjust the expense based on how many shares actually vest, TSR awards are not “trued up” for performance.
2. The Methodology: Monte Carlo Simulation
The most common way to value these awards is a Monte Carlo simulation. This model simulates thousands (usually 100,000+) of potential future paths for the company’s stock price and its peer group’s stock prices.
- Path Dependency: The model tracks the stock price daily to see if specific hurdles or “caps” are hit.
- Probability Weighted: It calculates the payout for every single simulated path and then averages them to find the “expected value.”
- Present Value: That average future value is discounted back to the grant date using a risk-free interest rate.
3. Key Inputs and Assumptions
To run this valuation, an actuary or valuation specialist needs several specific data points:
- Volatility: How much the company’s stock price fluctuates.
- Correlation: How closely the company’s stock price moves in relation to its peer group—essential for Relative TSR awards.
- Risk-Free Rate: Usually based on U.S. Treasury yields for a period matching the performance window.
- Dividend Yield: Whether dividends are reinvested or paid out to the participant.
- Peer Group Data: The historical stock prices and volatilities of all companies in the comparison group.
4. Sample TSR Valuation Report
The following resources provide insight into the depth and the services that MITI can deliver:
TSR White Paper
TSR Working Paper
TSR Valuation Consulting Services
TSR Calc Online