In the latest installment of the Salzburg Questions for Corporate Governance, Stephanie Bertels reflects on key takeaways from "Driving Accountability: Integrating EESG into Executive Compensation," an interactive conversational program which took place on May 6 as part of the Salzburg Global Corporate Governance Forum
This article is part of the Salzburg Questions for Corporate Governance series by the Salzburg Global Corporate Governance Forum
The question above was posed to participants at our recent Salzburg Global Corporate Governance Forum program on Driving Accountability: Integrating EESG into Executive Compensation. The program brought together leaders in the field of compensation, key stakeholders initiating and supporting proxy proposals linking environmental, employee, social, and governance (EESG) performance to compensation, and dozens of global directors and executives from companies that have or are considering factoring EESG into their compensation schemes. In this post, I reflect on what my co-host John Cannon and I took away from this conversation.
The program was motivated by the pressure and momentum building around the need to account for sustainability and other EESG issues in rewards systems. In particular, there has been a growing number of shareholder resolutions requesting the adoption and disclosure of environmental, employee, social, and governance factors into executive compensation. Earlier this year, we also saw a spate of announcements from companies like Apple, Mastercard, and Chipotle that were following suit.
While boardroom discussions on executive compensation have historically focused on retention and aligning management decision-making with delivering on shareholder value, nearly half of the UK's 100 largest companies now use an environmental, social, and governance measure when setting targets for executive pay.
And, while participants cautioned that the metrics to track and assess EESG performance must continue to mature, there was also a recognition by both issuers and investors that the inclusion of EESG criteria into executive compensation programs is a trend that is here to stay.
Participants pointed to increasing interest among investors, who have recognized that EESG factors represent risks and opportunities that should be managed like any others. They also pointed to broader societal concern over excessive compensation and the disconnect between the behaviors currently incented by executive compensation schemes and what are seen to be desired societal outcomes such as reducing inequality, promoting gender and racial diversity or addressing the climate crisis.
There was a sense that given the events of the past year, "failure to address these societal issues could be seen as a moral failure of leadership and of the board." As one participant noted, "If an issue is this important, you should hold management to account …and a key means to do that is the incentive plan."
When discussing the merits of including EESG in executive compensation, participants stressed the signaling value. It was felt that aligning incentives in this way helps to foster executive-level commitment around these issues and, in the words of one participant, "provides the permission to care about them." Others pointed out that including EESG factors in compensation can empower leadership and the broader management team to move projects ahead that might not meet traditional financial metrics.
Our participants also had some sage advice for others as they navigate this journey. When new incentives are introduced, there can be significant unintended consequences. They advised moving carefully and step-by-step and cautioned that complexity in executive compensation design should be avoided. Investors noted that it raises red flags when EESG is totally separate, is too complex, or when it is all lumped together as one component of compensation.
Instead, directors should view EESG integration as part of a broader compensation strategy. Where possible, they should tie executive compensation to key measures that managers at all levels of the organization are using to assess their everyday EESG performance.
They also stressed that metrics should reflect the pathway to long-term goals and be anchored to clear interim targets. They should be tied to credible, relevant goals and include clear short-term milestones.
Executives should be evaluated against meeting these shorter-term targets to ensure the company stays on track to reach its longer-term commitments. Another participant offered that incentives could even be designed that reward delivering on these targets early.
And, while the focus of our conversation was on executive compensation, several participants noted that the rewards offered related to EESG performance should ideally be shared fairly across the organization.
Our participants also had some words of caution. To start, you'll want to ensure that any changes you make to compensation are designed to incent a fundamental shift in behavior and move the organization forward on its EESG journey, not simply to reward existing compliance-based behavior.
You will also want to ensure that integrating EESG into compensation isn't perceived as another way to pad executive pay or further contribute to inequality (especially given that intrafirm inequality can negatively impact productivity and financial performance).
And participants rightly cautioned that executive compensation is only one lever in shaping decision-making and what is tested needs to be taught. Boards and executives need to continue to build their literacy in these topics and ensure that the executive team has the skills to deliver on EESG objectives credibly.
Stephanie Bertels is the director of the Centre for Corporate Governance and Sustainability at the Beedie School of Business of Simon Fraser University in Vancouver, Canada. She founded and leads the Embedding Project, where she works with dozens of global companies to help them embed sustainability into their operations, governance and decision-making. Her most recent work draws upon a review of over 3200 board position statements and interviews with over 200 global CEOs and board chairs to explore how corporate governance and corporate strategy processes are shifting to account for environmental and social constraints. She has previously worked as an environmental engineer and is a trustee and chair of SFU's Academic Pension Plan. She has a Ph.D. in strategy and global management and sustainable development from the University of Calgary, an M.Sc. in petroleum engineering from Stanford University and a B.Sc. in geological environmental engineering from Queen's University. She is a Fellow of Salzburg Global Seminar.
The Salzburg Questions for Corporate Governance is an online discussion series introduced and led by Fellows of the Salzburg Global Corporate Governance Forum. The articles and comments represent opinions of the authors and commenters, and do not necessarily represent the views of their corporations or institutions, nor of Salzburg Global Seminar. Readers are welcome to address any questions about this series to Forum Director, Charles E. Ehrlich: cehrlich@salzburgglobal.org. To receive a notification of when the next article is published, follow Salzburg Global Seminar on LinkedIn or sign up for email notifications here: www.salzburgglobal.org/go/corpgov/newsletter