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

G&A's Sustainability Highlights (08.02.2019)
Aug 6, 2019 12:30 PM ET

For several decades now, investors have increasingly focused on issues involving executive compensation.  Remember Graef S. Crystal?  Back in 1992 the former compensation consultant to the largest corporations became an activist focused on “excess” pay arrangements for U.S. corporate CEOs (his book was “In Search of Excess – the Overcompensation of American Executives”).

Every company faces the same questions, he explained:  in terms of compensation of the senior management team, how much and how?  He explored the various approaches of the day and set the foundation for conversation about CEO comp over the ensuing years.  

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 been a factor.

And as we have seen with the passage of new laws and operating rules of the road – for example in Dodd-Frank legislation in 2010 – the Congress attempts 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 corporate proxy statement today greatly illuminates to the board thinking in the structuring of basic compensation plus 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 to Graef Crystal’s how much and how?

These are real challenges for boards in considering the how --- 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?

The authors (both experienced compensation advisors) 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 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.  

This is just the introduction of G&A's Sustainability Highlights newsletter this week. Click here to view full issue.