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Why tying CEO pay to sustainability still isn't a slam dunk

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 number of companies are beginning to tie environmental goals to executive compensation.

That means executives at impacted firms now have to weigh entrenched operational variables, such as greenhouse gas emissions, against short-term financial outcomes.

The shift is part of a broader push to more explicitly tie Environmental, Social and Governance (ESG) metrics — encompassing broader corporate social responsibility areas, such as labor and local community impacts — to core business models. It's an endeavor that skeptics still say can entail compromising on profitability and growth prospects.

NGOs are just beginning the process of analyzing how executive compensation and sustainability ultimately might affect business outcomes.

In a report published by the sustainability non-profit Ceres along with Sustainalytics, 24 percent of the 613 largest publicly traded companies have tied sustainability to executive compensation, which is an increase from 15 percent in 2012.

Yet, a majority of the sustainability initiatives in the report are related to compliance, such as safety issues, that companies are required to disclose anyways. The report states that only “3 percent (19 companies) link executive compensation to voluntary sustainability performance targets, such as greenhouse gas (GHG) emissions reductions.”

“At the end of the day people are motivated by their pocketbooks,” said Veena Ramani, Ceres' senior director of corporate programs. “So I think investors have come to recognize that if you want companies to take this stuff seriously, you’re going to have to link it to people’s compensation.”

The green bonus

Because sustainability initiatives are often farsighted and have little impact on short-term financial performance, few multinational companies are integrating related variables into executive pay.

That makes the publicly traded Dutch materials and life sciences company Royal DSM unique. The company with $9 billion in annual revenue last year tied 50 percent of short term executives bonuses to sustainability goals.

The company began these initiatives in 2010 for over 400 company executives. Compensation-related goals included reducing greenhouse gas emissions, using more sustainable products and services in the supply chain and reducing water usage.

“We see that this is a means to create a sustainable competitive advantage,” said Royal DSM North America CEO Hugh Welsh. “Going forward, we understood that we wouldn’t just be supplying products to customers, we’d actually be supplying sustainability right beside those products.”

The company uses objective traditional sustainability metrics — such as measuring greenhouse gas emissions, water usage and energy consumption — along with initiatives tied more closely to product development and marketing.

Welsh said that the company's Eco+ products are products than have a lower carbon footprint that a competing product on the market, while having at least the same functionality. The company’s goal is to have 80 percent of new products in its pipeline be Eco+ by 2015, as well as 50 percent in total sales.

Overall, DSM reduced greenhouse gas emissions by 10 percent last year, along with reducing total energy usage by 8 percent.

“The reaction internally amongst the executive community is about what you expect whenever you touch someone’s money," Welsh said. "It becomes a priority."

Seeing beyond the short term

While Welsh believes that the company’s sustainability initiatives will have a direct impact on the company’s bottom line, will other companies follow suit?

“This [executive compensation linked to sustainability] is still an extraordinary rare phenomenon with large cap companies, and I don’t see that changing much in the short term,” said Bennett Freeman, former senior vice president for social research and policy of the Calvert Group.

Alcoa and Unilever represent two of the few large cap companies that are embracing this new way to incorporate sustainability.

As the third largest aluminum producer in the world, Alcoa has made 20 percent of executive compensation tied to safety, environmental stewardship, voluntary GHG reductions and energy efficiency, according to the Ceres report.

Unilever, the Dutch-British consumer goods company and familiar sustainability leader, has tied part of the CEO’s bonus directly to sustainability.

Last year, CEO Paul Polman was the benefactor of a $722,230 bonus for meeting sustainability targets including reducing greenhouse gas emissions, water and waste as part of the company’s “sustainability living plan.”

“This is going to be an evolution of many years and indeed over generations. In the meantime, we need education as well as role models like Paul Polman,” said Freeman.

Freeman suggests this evolution will take a number of years in part because of lapse regulation and enforcement by regulatory bodies such as the Securities and Exchange Commission.

Sustainability concerns have not been made a priority by the SEC. With the exception of two pieces of legislation regarding disclosing climate change as a risk and conflict minerals in the eastern Democratic Republic of Congo, the agency has issued little guidance requiring companies to list sustainability risks.

Because the SEC has not issued significant guidance about sustainability and environmental risks, it requires companies to voluntarily report and integrate sustainability into financial statements.

While many companies are just beginning this process, getting the majority of publicly traded companies to integrate sustainability with executive compensation might seem like a pipedream. Executive compensation for publicly traded companies has to be approved by members of the board of directors.

“This is a tough nut to crack because it requires the board to explicitly embrace the proposition that sustainability is a core indicator of the CEO’s and internal company’s responsibilities and performance, and that is a bridge that very few boards … are willing to cross,” said Freeman.

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