As Investors Suggest Tying Executive Compensation to Progress in ESG / Sustainability – Can This Be Factored Into Today’s Corporate Pay Programs?

by Hank Boerner – Chair and Chief Strategist, G&A Institute

For several decades now, investors have increasingly focused on issues involving executive compensation. 

Remember Graef S. Crystal?  Back in early 1990s the former compensation consultant to the nation’s largest corporations shape-shifted and became an author and activist focused on what he believed to be “excess” pay arrangements for U.S. corporate CEOs. (His 1992 book on the subject was a best-seller, “In Search of Excess – the Overcompensation of American Executives”.)

Crystal began his career at Towers Perrin, where he worked for two decades as a consultant to major companies on corp comp; he also taught at Haas School of Business (University of California, his alma mater). In later years Graef Chrystal was a leading commentator for Bloomberg News. (He passed away in April 2017.)

Every company faces the same questions, he explained in simple terms:  in terms of compensation of the senior management team, how much and how? 

In his work as a leading CEO comp consultant he explored the various approaches of the day and set the foundation for conversation about CEO comp over the ensuing months and years. (As corporate boards set compensation practices in place.) He was a major influence in his time as consultant in developing compensation programs for large public companies.

In 1989 he “switched” sides from advising Coca Cola et al and became a very vocal critic of CEO compensation schemes without having formal, accountable pay-for-performance systems in place.

For Crystal, It Was All About Pay-for-Performance

Let’s recognize here that much progress has been made in linking pay to performance over the years since Crystal’s (and others’) call for reform of the compensation packages of publicly-traded companies.  Institutional shareholder activism has certainly been a factor.

And as we have seen with the passage of new laws and operating rules of the road, there is increasing focus on CEO compensation. For example the Dodd-Frank legislation of 2010 – the the U.S. Congress attempted in the new statutes to address the issue. (The annual public report on the ratio of CEO pay to the median worker in U.S. public companies came about this way.)

The Dodd-Frank rules call for an advisory shareholder vote on the corporate compensation programs (the frequency of this vote to be approved by the shareholders).

The corporate proxy statement today greatly illuminates the board thinking in the structuring of basic executive compensation for the top executives — pay levels plus a growing variety of incentives.

More recently, there are calls from some institutional investors to have executive compensation tied to performance related to ESG / sustainability.

Authors Seymour Burchman and Blair Jones writing in The Harvard Business Review see “…the final link in the chain of improving corporate accountability for sustainability is to tie improvements to pay”. 

That gets us closer to Graef Crystal’s fundamental questions of how much and how?

These are real challenges for boards in considering the how of incentives tied to ESG — the number of possible sustainability improvement goals grows by the day. 

The long-term efforts to realize payback from most ESG initiatives don’t easily fit into the usual annual or three-year incentive timeframes. 

And then because incentives are typically tied to financial results…revenues, profit, returns…how do you weight the non-financial aspects of the business…and develop clear ROIs for ESG?

The authors — both experienced compensation advisors, like the late Graef Crystal — set out five steps to designing sustainability incentives to address these challenges and more to enable boards and management teams to create incentives that respond to internal and external stakeholder priorities.

Briefly, these are:

(1) reexamine the context – what are your measurements?;

(2) clarify the organizational scope – where to apply the incentives;

(3) quantify the duration (time horizon);

(4) consider the ends and the means – what are the goals?;

(5) and then structure the incentives. 

The authors spell out the specifics of each of the five steps.

The public discussion that Graef Crystal helped to start on the subject of senior management compensation more than a quarter-century ago continues today with varying expectations of investors about how much and how, but with far greater transparency on the part of companies about their plans.

We are now seeing companies acknowledging the importance of factoring progress in sustainability efforts into the pay packages. 

We think corporate boards and managements, and investors in the enterprise, will find the Top Story of importance in the context of the growing expectation that executive compensation will somehow reflect the continuing embrace of sustainability (or “ESG”) by public companies of all sizes in the U.S.A. – and by a growing number of mainstream asset owners and their managers.

This Week’s Top Story

5 Steps for Tying Executive Compensation to Sustainability
(Source: Harvard Business Review) – The final link in the chain of improving corporate accountability for sustainability is to tie improvements to pay. In our last article, we explained that companies should use incentives to motivate executives to tap big…

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