Is It Time to Pay Executives To Do The Right Thing?

By DirectorCorps

November 18, 2019 All Industries Compensation

One significant change in executive pay packages in the last several years has been an effort to tie more compensation to shareholder value. Proxy advisory firms have pressured publicly traded companies to remake their pay packages to tie the CEO’s performance with shareholder return or the performance of the company’s stock, which puts shareholders front and center.

“Until this August, the emphasis has been on shareholder value,” says Richard Harris, an executive compensation advisory partner at the global consultant AON.

But in August, the Business Roundtable redefined the purpose of the corporation to include a commitment to all stakeholders, not just shareholders. A group of companies like JPMorgan Chase & Co., Johnson & Johnson, Pfizer and Exxon Mobil Corp. think that corporations should consider the needs of communities, customers, vendors and employees. What that means for executive pay remains unclear.

Will companies start paying C-suite executives based on how happy the employees are? Will they get annual bonuses if the company tops the list of Consumer Reports? Metrics like  customer satisfaction can be an aspect of bonuses for retail employees below the C-suite who directly engage with customers, Harris says.

But in an age where investors are already pressuring companies to improve their practices regarding environmental, social and governance concerns (ESG), is the C-suite the next to see incentive pay tied to such concerns?

Already, some companies are using ESG metrics to reward senior executives, but they’re in the minority. “We haven’t seen a lot of adoption of actual metrics into pay packages so far,” says Nicole Bouquet, head of Sustainability Advisory Services for the consulting firm ISS Corporate Solutions. According to a report from the environmental nonprofit organization Ceres on 600 of the largest publicly traded companies in the United States, 24% tied executive compensation in 2017 to sustainability metrics. The percentage that linked executive compensation to metrics other than compliance or regulation-driven standards was much smaller, only 8%.

Part of the problem of tying pay to specific ESG goals is deciding what metrics to use, says Susan O’Donnell, a partner at Meridian Compensation Partners. If you want more diversity among the senior ranks of your company, will you tell the CEO to hire a certain number of women and minorities? “I would say there is an evolution and we’re in the early stages,” she says. “The metrics are probably the most challenging area.”

Howard Cole, an employment and labor attorney and partner at Lewis Roca, says ESG metrics tend to be a broad data spectrum designed to relate to a very large spectrum of companies. For instance, Microsoft Corp. and many other companies have adopted the United Nations’ Sustainable Development Goals, including goals that relate to gender equality and climate change. Many others have signed global agreements to reduce greenhouse gases, Bouquet says.

“At this time, I see companies looking for comparisons to a smaller set of direct and indirect competitors in the same industry to ensure competitive compensation packages,” Cole wrote in an email, although he added that could change going forward.

A May 2019 study of 135 private and public for-profit and nonprofits by the benefits advisor Mercer found that 30% of respondents use ESG metrics in incentive pay, but that’s broad-based among all employees, not just senior executives. It also tends to be a small factor, making up typically less than 5% of overall metrics used. The industries most likely to use ESG factors in incentive pay are mining and metals (82%) and energy (52%), Mercer found. These industries use a lot of natural resources, which makes sustainability in incentive pay more understandable.

Energy companies and others have signed global agreements to reduce greenhouse gases and adopted internal metrics to move to 100% renewable energy. That’s bleeding into incentive pay packages for the C-suite.

For example, Occidental Petroleum Corp. in 2019 increased the weighting of its sustainability goals from 3% of the annual cash incentive for executives to 10%. The board also has a standing environmental committee that oversees the company’s environmental, health and safety programs.

Other popular metrics for incentive plans include employee engagement and diversity. Tying CEO pay to gender pay equity is a possibility for the future, Harris says. But he predicts it will take a few years for companies to start tying C-suite pay to the fortunes of other stakeholders besides shareholders. “We are all trying to figure out what this means,” he says.