More companies are using corporate responsibility benchmarks when calculating remuneration for top executives in a bid to reward sustainable behaviour
Crisis, what crisis? Despite the downturn, the sums earned by top executives keep on climbing. Some companies reined in boardroom bonuses in 2009, but pay for UK FTSE 100 chief executives still rose by 6% to an average of £3.8m, according to the Sunday Telegraph’s Pay Report.
Remuneration for top bosses is made up of salary, bonuses and share awards, with the level of the latter two determined by company performance. Usually, broadly speaking, performance is judged by the share price. The higher the share value, the happier the shareholders, and the bigger the bonus.
But some companies are looking at measuring performance in different ways. A study by responsible investment research group Eiris, published this year by the European Sustainable Investment Forum (Eurosif), showed that 29% of FTSE Eurofirst300 companies have “some commitment” to linking bonuses to company progress against environmental, social and governance (ESG) benchmarks, rather than just against financial indicators.
Eiris analyst Kazutaka Kuroda says this linking is a response to shareholder demand. Investors want non-financial performance reflected in the bonuses given to executives because there are “longer-term financial stability and value-creation benefits of doing so. Increasingly, investors are seeing good performance on ESG issues as a proxy for good management overall.”
Laura Maanavilja of Brussels-based business network CSR Europe concurs. She says a growing number of companies are starting to include corporate responsibility or sustainability criteria in their remuneration systems. Firms are beginning to “develop systems that highlight the links between ESG issues and business strategy”, she says.
The phenomenon is relatively new, and evolving. “We’re still at the beginning of it,” says Sophie Rahm, Eurosif’s head of research. She says the economic and financial crisis, which has shone a spotlight on executive pay, was the “trigger” for companies to look more closely at how remuneration can be better justified and linked to long-term performance. “It’s a reactive trend; companies are rethinking their [pay] strategies,” she says.
Boardroom resistance
Rahm argues that although investors would like to see more companies incorporating responsibility indicators in executive pay structures, there may be resistance in some boardrooms, where remuneration is a delicate issue that raises concerns over confidentiality and commercial sensitivity. “As soon as you touch on the money side of things, it is hard to impose transparency,” she says.
There are also practical issues. Rahm says ESG-linked pay is more easily introduced in firms where ESG is part of the overall strategy. But “it is only very rarely that ESG performance is vertically integrated within the company”, she says.
Another barrier is the absence of standard models for establishing meaningful benchmarks for calculating ESG-related bonuses. CSR Europe’s Laura Maanavilja says “there is a need for a better understanding of the non-financial drivers of value and how they can be measured and managed”. She adds that “integrating ESG factors into management models, performance assessment and reward systems is a key challenge”.
Rahm says external guidance, identifying for example which benchmarks best suit certain sectors, will make the linking of pay to ESG performance more credible. Credibility would also be boosted by external audits “of the ESG performance and its associated remuneration scheme”, but companies may be wary of exposing themselves to such scrutiny.
More generally, companies starting now to integrate pay and ESG performance may have to wait some time before a meaningful link can be made. “It may take as long as 10 years for a company to reach a satisfactory ESG performance,” Rahm says.
Some sectors certainly seem to be quicker than others to reform their remuneration systems. Eiris’s Kuroda says: “In sectors with a high exposure to ESG risks, such as oil and gas, chemicals and food production, more than half of companies have remuneration schemes that are linked to performance on ESG risk management.”
However, in the financial sector, progress has been more limited. Only 15% of top banks and 18% of insurers have moved towards ESG-linked remuneration, according to Eiris’s research.
There are also differences from country to country. “The Netherlands is leading the way, with increasing numbers of UK companies also displaying good practice,” Kuroda says. Prominent Dutch firms that have changed their remuneration policies include bank ING, chemicals firm AkzoNobel and haulage group TNT. However, in Japan, Eiris could only identify one company, Tokio Marine Holdings, the largest non-life insurer, that had changed its approach.
Dutch leadership in modernising pay may have something to do with legislation in the Netherlands, which requires companies to put executive remuneration packages to a binding shareholder vote. This means there is pressure for companies to present shareholders with something they will approve of. In the UK, meanwhile, as well as in France and Germany, shareholders may get to vote on remuneration policy, but the outcome of the votes is considered only advisory.
Lack of clarity
Where remuneration has been linked to ESG performance, the pay policy can be opaque. The Eurosif report notes that while companies may report a remuneration system linked to ESG performance, they do not always disclose how this system is implemented. Many companies do not give details of the indicators they use, or even identify the ESG areas they are focusing on, though health and safety are believed to be the most common concerns.
Insurance giant Aviva is something of a trailblazer, having built targets relating to “customer advocacy and employee engagement” into executives’ remuneration since 2005. Other targets have since been added, including environmental benchmarks in 2007, says Aviva’s Vanessa Rhodes.
However, even Aviva’s 2009 directors’ remuneration report, which is rich in acronyms and jargon, gives little clear information about how corporate responsibility goals are evaluated relative to executives’ bonuses, or about the proportion of a director’s pay package linked to achieving them. The report notes only that Aviva’s remuneration committee “ensures that the non-financial business measures and individual objectives [set for directors] reflect adequately the company’s environmental, social and governance responsibilities”.
The report is more forthcoming on the “customer advocacy and employee engagement” parts of boardroom pay, which each account for 10% of executive bonuses. To assess “employee engagement” performance, Aviva surveyed its 37,500 staff and ranked itself against a goal of “reaching the upper quartile positions compared to the relevant global and national norms on leadership and engagement over time”. Information on how this comparison is done and the benchmarks used is lacking. In any case, it is clear that there is room for executives to do better, because they only received half of the maximum possible 2009 “employee engagement” bonus. Even so, chief executive Andrew Moss took home a pay package worth more than £4.5m.
Detail may be sketchy, but Rhodes says the overall incorporation of non-financial performance measures in boardroom remuneration “sends a message internally”, and shows that corporate responsibility is “not just about talking the talk”. She adds that Aviva believes that other companies should put in place similar policies. “Nothing quite focuses the mind on targets as linking them to people’s pay.”
More straightforward
Other firms have more straightforward bonus plans. Directors of paint and chemicals firm AkzoNobel get a base salary, a cash bonus based on annual financial results, and an allocation of shares for longer-term performance. Half of this latter bonus is dependent on the company’s average positioning over a three-year period in the Dow Jones Sustainability Index (DJSI). The approach is meant to incentivise not only the top executives; the bonus system also extends to AkzoNobel’s top 600 managers within its different business units.
Tim van der Zanden, AkzoNobel’s head of external relations, says shareholders “hugely voted in favour of this change”, with 99% backing it when it was put to a vote. Discussions with external bodies such as sustainable investor forums helped to shape the scheme.
The scheme was put in place because “our board and supervisory board are fully convinced that we need to manage financial issues as well as non-financial issues, in order to grow our business,” van der Zanden says. “We manage on value and values.”
Van der Zanden plays down the barriers to the introduction of the policy. Measuring ESG performance via a ranking in the DJSI provides a straightforward and credible measure that is easy for outsiders to grasp, he argues.
Banking giant ING has taken a similar approach. At the firm’s annual meeting earlier this year, shareholders approved a remuneration plan that links 40% of the variable element of directors’ pay to sustainability targets. The policy took effect retrospectively, from January 1 2010.
ING’s Carolien van der Giessen says the company’s top 200 managers will be covered by the bonus plan, and that further extensions of the scheme to other personnel may be considered. “The management layer below [board level] must support the executive board or it will be hard for directors to achieve [their targets],” she says.
This approach echoes the motivations of other companies with ESG-linked remuneration. “Non-financial objectives contribute to the sustainability of the business,” van der Giessen says. “It is here to stay and it will develop. It makes sense to take it into account in the remuneration policy.”
Work in progress
Linking executive pay to ESG performance may be popular with shareholders, but it is so far unclear if it produces great leaps forward in corporate sustainability. AkzoNobel’s Tim van der Zanden says it is too early for the company to make a judgment about the results of its remuneration policy, but it is part of a general shift in values. “We are looking more and more at sustainability in decisions at all levels,” he says.
Aviva’s Sue Winston says it can be “difficult to isolate” the impact of remuneration policy from other elements of a corporation’s sustainability strategy. However, ESG-linked pay is a signal and a way of highlighting the issues that will have an impact on a firm’s long-term viability.
Although there are so far no standard models linking corporate responsibility performance to executive remuneration, there are similarities in the approaches taken by Dutch firms such as AkzoNobel and ING. Both assess environmental and other indicators over three-year periods, with directors only allowed to cash in ESG-linked shares at the end of each period.
Schemes for measuring corporate responsibility and linking it to the decisions made by company boards will certainly become more sophisticated. Companies hope this will shift attention away from accusations of excessive pay, and onto the broader issue of sustainability.