Momentum builds to link CEO salaries with sustainable measures

The Sustainable Shareholder

Momentum builds to link CEO salaries with sustainable measures

There’s a growing trend in the mechanisms and measures used to determine corporate executive compensation. From increased attention to Environmental, Social and Corporate Governance (ESG) measures to “say on pay” votes, these changes have been driven by factors such as increased dialogue between management and shareholders as well as the financial crisis.

"Many companies are putting in more performance-based compensation plans and they are addressing items that shareholders often criticized, such as excessive severance, perks, federal income tax payments, and pensions,” SEC Commissioner Luis Aguilar said recently.

In these troubled financial times, it appears that the trend to increase executive accountability will only become more widespread. Millions of Americans have been laid off in the past five years to preserve corporate profitability and shareholder value, yet executive salaries have continued to rise with no end in sight. In 1980, the average S&P 500 company CEO received 42 times the average worker's pay, but in 2011 the rate was 380 times the average -- up 14 percent from the previous year.

Four hundred companies who received federal stimulus funds for troubled assets are required by the SEC to implement “say on pay” initiatives which require a shareholder vote on executive compensation at least once every three years. While dozens have started the process, hundreds more companies are scheduled to follow suit.

Intel, Alcoa, and Campbell’s Soup already employ executive evaluation measures which can include the company’s carbon footprint, employee morale, community impacts and cost savings through recycling.

And companies interested in receiving guidance on how they can identify appropriate ESG metrics, link them to executive compensation, and properly disclose such practices can now refer to a UN report issued this month about integrating ESG issues into executive pay.  

Photo of money in shirt pocket provided by Helder Almeida via Shutterstock

Say on pay

Shareholders have already rejected compensation packages at companies such as Hewlett-Packard, Stanley Black & Decker, and Constellation Energy. Such critical votes -- even those that don’t earn majority shareholder approval -- change the context of the compensation discussion by adding significant pressure on other (non-TARP) companies to implement a similar advisory vote.

The most publicized 2012 say on pay vote occurred in April at Citigroup’s annual meeting, where 55 percent of shareholders rejected management’s proposed executive compensation package. Citi's compensation committee now will assess the CEO not on profitability, but on measures such as talent management, organizational culture and risk management. It’s a marked departure from the longstanding tradition of evaluating management on financial performance alone.

Though “say on pay” votes are non-binding and advisory in nature, the requirement represents a historic victory for investors who believe that transparency and accountability directly correlates to the value of company shares. Such a requirement may not have even been implemented if the 2008 financial crisis had not occurred.

Company-initiated CEO compensation measures

Intel, which has been providing a link between ESG metrics and compensation since 2005, is often lauded for embedding ESG issues into its operational practices by including nearly 300 specific measurable issues upon which executives can be evaluated, including the company’s carbon footprint, cost savings through recycling, and employee morale.

Aluminum manufacturer Alcoa is noted for its compensation incentives that increase representation of women and minorities in professional and managerial ranks, improve safety statistics, reduce carbon emissions and for its clear disclosure of its ESG metrics and executives’ associated performance against them in its annual proxy filings.

And Campbell’s Soup has some of the most comprehensive criteria, including diversity, safety, employee engagement, community impacts such as reducing hunger and childhood obesity in its communities of operation and broader environmental goals in areas of energy, water and recycling.  

Measurement criteria

So what non-financial performance metrics should be measured when evaluating executive performance? Many sustainable investors believe that linking executive compensation to Environmental, Social and Corporate Governance (ESG) performance is an appropriate incentive model that supports long-term shareholder value while benefiting society and the environment.  And sustainable and responsible investors acknowledge that executive accountability has a direct correlation to long-term share price.

Dozens of companies are beginning to agree, and while a handful are using a broad array of sustainability performance criteria in their executive compensation evaluation, most are focused primarily on workplace diversity in areas of hiring, promotion, and management. Others assess performance by using health and safety issues as measures.

The United Nations’ “Integrating ESG Issues Into Executive Pay” report recommends that the incentives be stringent and challenging, operate in line with the business strategy, have a suitable timeline for achievement and be subject to clawback provisions in the event of discovered non-compliance.

Another 2012 report from Ceres tracks corporate progress across 22 governance, stakeholder, disclosure, and performance metrics. “The Road to 2020”  identified 39 companies (seven percent of the 600 assessed) that already tie executive compensation to specific ESG performance targets. Another nine percent do so in broad terms without identifying specific ESG targets and weights.

A company’s willingness to tie executive compensation to achieving specific milestones on ESG metrics demonstrates a new and higher degree of commitment to executive accountability, one that sustainable and responsible investors acknowledge has a direct correlation to long-term share price.