Over the past several years, we have observed a notable shift in how oil & gas companies approach relative Total Shareholder Return (TSR) as a performance metric in their performance share unit (PSU) programs. One notable development has been the inclusion of the S&P 500 as a single TSR performance peer alongside industry competitors, to demonstrate accountability for performance relative to the broader (non-oil) market. As the S&P 500 becomes increasingly weighted toward the largest seven companies in the tech sector, these oil & gas companies may reasonably question whether the S&P 500 is still relevant as a stand-in for broader market performance.
Why use the S&P 500 as a TSR performance peer?
For years, oil & gas companies have relied on TSR relative to industry peers as their primary measure of long-term performance. The rationale is sound: benchmarking performance relative to peers helps filter out the overwhelming influence of commodity price, holding management accountable for outperforming peers who are experiencing the same industry environment. However, this approach can hit a wall with shareholders during extended periods of sector-wide negative returns and underperformance relative to the broader market. In this context, above-target payouts to management can be hard for shareholders to stomach.
During COVID, frustration with the prevailing approach came to a head. Investors were fleeing oil & gas stocks, and those that remained were demanding changes. One common response in the Exploration and Production (E&P) sector was to add a broader market index as a single TSR performance “peer.” As a generally accepted benchmark of investment return, the S&P 500 was a popular choice to signal accountability for beating the general market and potentially attract traditional investors back to the sector. Since appearing in the E&P sector, this new design feature has been adopted by a growing number of oil & gas companies.
The impact of adding the S&P 500 as a single peer may be viewed as mostly symbolic. In a large TSR performance peer group, moving up or down by one position may not have much impact on the payout calculation. However, as many oil & gas companies find the pool of relevant industry-specific performance peers shrinking due to consolidation, the impact of performance relative to a single peer becomes increasingly material.
Does Tech Weighting Undermine Relevance?
The S&P 500’s appeal as a TSR peer lies in its status as a proxy for the broader U.S. equity market. However, the S&P 500 is a weighted index, and the “Magnificent Seven” technology stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) currently account for roughly one third (30-35%) of its total value.
For an oil & gas company who wants to measure itself against “broader market” returns, the S&P 500 may no longer feel appropriate as a TSR peer. At the same time, shareholders who invest across sectors may feel different. A company that can’t keep pace with the broader market, tech-heavy or not, may struggle to justify its place in a diversified portfolio. From this perspective, the S&P 500 remains relevant precisely because it mirrors the opportunity cost of capital.
The challenge for industry companies considering the S&P 500 as a peer lies in balancing perception and fairness. Investors may value broader market accountability. Investors and executives may also question why an oil & gas company includes an index tethered to a single sector that is so detached from the company’s operational realities.
Refining the Approach: Considering Alternatives
If the S&P 500’s tech tilt feels off-target, what are the options? Several alternatives could better balance industry relevance with broader market accountability:
1. Equal-Weighted S&P 500: an equal-weighted version of the S&P 500 reduces the dominance of the Magnificent Seven, leveling the field across all sectors in the index. However, when we swapped the equal-weighted S&P 500 for the traditional market cap-weighted version, we found that performance differences were rarely significant enough to materially shift TSR rankings within an oil & gas peer group. This outcome suggests that while shifting to the equal-weight index may appear fairer, it is unlikely to have a materially different impact on PSU outcomes.
2. Custom Market Subset: a subset of the S&P 500—excluding oil & gas companies but including a cross-section of non-energy industrial sectors—could offer a middle ground. A custom subset can provide a general market reference that may be more relevant as a general market investment alternative to oil & gas, while avoiding direct overlap with industry peers. This approach can also be more administratively complex than accepting the results of an established index and requires careful thought to ensure stability and transparency.
3. Alternative Indexes: there are other indexes that could provide a viable cross-section of the broader market. Some examples include:
• The Russell 3000 with its broader scope;
• The S&P MidCap 400 where size limitations help ensure that the most valuable companies in the market don’t have an outsized impact on results; or
• A broader industrial index like the S&P 500 industrials, comprised of companies in sectors that may be more comparable to oil & gas.
Any of these alternatives might better reflect a diversified market without the S&P 500’s extremes. Each also carries its own trade-offs in terms of recognition and alignment with investor expectations.
Key Considerations
Whether your company already uses the S&P 500 as a TSR peer, or is contemplating using a different general market reference, the decision merits careful consideration. Here are key questions to guide your thinking:
• Investor Alignment: do your shareholders view outperformance relative to the broader market as a priority, or are they more focused on sector leadership? How will they perceive the S&P 500’s tech weighting? Would a different index, perhaps even a broad industry-specific index like the XOP be more appropriate?
• Plan Effectiveness: does the S&P 500’s inclusion meaningfully influence payouts, or is it largely symbolic? Are executives motivated—or frustrated—by its presence?
• Relevance Check: does the S&P 500 reflect your capital market competition, given its evolving composition? Is your company large enough to be a participant in the S&P 500? Would an alternative index (e.g., a mid-cap or small-cap index) or index subset better balance fairness and accountability?
• Communication Strategy: how will you explain this choice to stakeholders, especially if sector performance diverges sharply from the broader market?
Bottom Line
The S&P 500 role as a TSR peer offers a ready-made bridge between industry realities and investor expectations, but its tech-heavy bias raises questions regarding its fit for oil & gas. There’s no one-size-fits-all answer. Your company’s business strategy, value proposition, shareholder base, and risk profile should shape the path forward. As the energy sector evolves, so too should tools for measuring success. When considering design features for long-term incentive programs, the question isn’t just whether the S&P 500 works today, but whether it will tomorrow.