Should Public Company Boards Tie ESG Performance Metrics To CEO / C-Suite Compensation & Incentives?

Posted on June 4, 2015 by Hank Boerner – Chair & Chief Strategist

The topic of compensation and incentives for CEOs and close colleagues in the C-suite of public companies has been of interest to the sustainable & responsible investment community, as well as a growing number of mainstream investors, especially since the early 1990s when CEO pay began to rise dramatically.  The board of directors approves the pay package, with consists of cash (salary, often a modest number), options, deferred compensation in the form of shares-to-be-earned, and numerous other benefits.  As discussions about executive compensation became headline news is such venerable media as The Wall Street Journal, focus of investors and numerous stakeholders became more intense.   The legitimate question is:  Exactly what should CEO pay and incentives reflect in large publicly-owned enterprises?
It became a popular trend in board rooms to acknowledge growing investor concerns and responding by establishing “pay-for-performance” approaches.  A CEO may earn more if the share price rises is one example of p-f-p.  (Of course, won’t all shareowners be happy if the share price rises on the CEO’s watch?)  But tying too much of the p-f-p to short-term gains is not a good thing, many engaged institutional investors say.  The board and C-suite should be looking out to the longer term and shaping incentives around the efforts to build a stronger, yes, more sustainable enterprise that will continue to prosper for all stakeholders over the decade, not the immediate reporting period.
The public dialogue on CEO pay began and has endured as part of the focus by activist investors on encouraging more effective corporate governance.  Reflecting the populist concern, the passage of Dodd-Frank reform legislation mandated shareowner voting on executive compensation plans (the vote is still “advisory,” not binding on boards setting pay packages).  Over the past decade, as more asset owners and their managers focused on corporate ESG performance and sustainability achievements, the idea of tying compensation to achievements in ESG performance has slowly entered the discussion about executive compensation. Tip-toed in, we might say.
In theory, what investor would not want to put their trust in the company that has outstanding ESG performance?  Is demonstrably more sustainable?  Ah, but what about the notion of tying CEO pay-for-performance to gains in ESG performance?  How do you reward the leader for leading the company’s achievements in reducing GhG emissions, reducing water use, reducing or eliminating waste-to-landfill?
A relative handful of companies are taking this approach – think of Unilever as a prime global example — but respected sustainability experts like Bennett Freeman (former SVP of the Calvert Group) observes — “Executive Compensation links to sustainability is still an extraordinary, rare phenomenon with large-cap companies…”
We believe there will be increasing discussion going forward among investors, and between investors and boards and company managements, about executive compensation and the relationship to corporate ESG performance. The new element for shareowner activists will be encouraging boards to frame executive compensation within the context of greater ESG performance and corporate sustainability.  We may have a long way to go before this becomes part of the broad discussion on effective corporate governance.  But the “G” in ESG has been steadily rising in importance for investors.
The story linked below presents excellent perspectives on CEO Pay/Sustainability (p-f-p) by reporter Keith Larsen on the GreenBiz platform. The Unilever sustainability p-f-p example is described as well as the efforts of Royal DSM North America, which embraced the concept back in 2010.
Why tying CEO pay to sustainability still isn’t a slam dunk
(Wednesday – May 27, 2015)
Source: GreenBiz – What does a company’s carbon footprint have to do with the paycheck of its chief executive? While sustainability is often categorized as a long-term play to mitigate both reputational and financial risk, a small but increasing…