The Magazine of Corporate Responsibility

Businesses Link Sustainability Objectives to Executive Pay

by Andrew Williams

When it’s time for salary reviews at Xcel Energy, a Minnesota-based energy company, earnings per share are not the only thing that matters.  In its 2009 corporate proxy statement, Xcel explains how a range of sustainability metrics fit into annual incentive objectives for all executive officers and how it weighs greenhouse gas reductions and safety performance alongside earnings per share.

Palm with a plant growng from pile of coinsCompany spokeswoman Patti Nystuen told the sustainability group Ceres, “Xcel believes strongly in providing long-term incentive opportunities that deliver awards on the achievement of specific performance goals linked to the success of the company and its long-term strategy in the core utility business.  These include financial and environmental goals."

Xcel is one of a small but growing group of pioneering companies, increasingly aware of the power that policies on executive pay can exert on sustainability behavior.

Seventy-five per cent of Xcel's award incentives have a performance-based vesting schedule based on earnings per share growth.  The remaining quarter of Xcel's awarded incentives are performance-based, relating to aspects of their environmental strategy, such as decreases in emissions.

"In 2007, payouts of annual incentive awards for the NEOs (named executive officers) and all executive officers, including those reporting to the chief executive, were determined entirely by attainment of corporate goals, which included targeted earnings per share, an environmental metric related to carbon dioxide emissions, and safety," Nystuen said.

Across the Atlantic

In Europe, the Netherlands seems to be ahead of other nations in tying remuneration to sustainability objectives.

Dutch banking and insurance giant ING said recently that social, ethical and environmental objectives are to form a component part of its top management executive pay structure.

“ING has formulated corporate responsibility ambitions and priorities, combined with a long-term plan and concrete targets,” the company says in its 2009 corporate responsibility report. “These targets are also part of the performance objectives of our Executive and Management Boards.” The company said there will also be a program for senior managers to work on real-life cases at NGOs in developing countries.

At least three other Dutch firms – chemical company Akzo Nobel, life sciences group DSM, and mail operator TNT – have tied executive compensation to environmental improvement and other objectives, including employee and customer satisfaction.

And in one case, the linkage of pay to sustainability has been introduced to justify potentially controversial management decisions.   The oil giant Royal Dutch Shell, in a disclosure regarding its development of Canadian oil sands resources, makes the point that the company is “actively managing environmental and social impacts,” specifically noting that  “performance on sustainable development is a key feature of management targets and remuneration.”

On the Boardroom Agenda?

These initiatives come in the wake of two reports from organizations, based on opposite sides of the Atlantic, which have argued that the integration of sustainability into executive pay structures is one of the best ways for businesses to marry the twin objectives of sustainability and profit.

The first, published last month by Ceres, the Boston-based coalition of institutional investors and environmental organizations, reveals that an increased focus on corporate governance following the financial crisis of the last few years has now forced environmental sustainability onto boardroom agendas.

"Corporate scandals and the current economic crisis have heightened demands for new approaches to governance, particularly in relation to executive compensation and risk management,” say the authors of the report The 21st Century Corporation: The Ceres Roadmap to Sustainability.

“As sustainability has risen up the corporate, investor and public policy agendas, it has become more fully integrated into these governance expectations," they add.

The report calls on boards to undertake a root-and-branch reorganization of remuneration structures and base executive pay partly on a CEO's ability to integrate sustainable practices into day-to-day operations.  It also highlights the fact that many regulators and shareholders are putting pressure on boards to do a better job of aligning executive pay and performance standards tied to more than short-term profits.  In this top-down corporate governance structure, it calls on companies to name directors who have expertise in environmental sustainability issues.

Critical Challenges

Meanwhile, in its third Remuneration Theme Report, the European Sustainable Investment Forum (Eurosif) has revealed that most European companies fail to link executive pay to environmental, social, and governance (ESG) performance.

The report highlights some critical challenges and opportunities for companies in relation to remuneration, incentives and long-term sustainability.  Research highlights and recommendations for shareholders and regulators include:

  • 29% of FTSE Eurofirst300 listed companies have some commitment to linking remuneration to ESG performance – although concerns exist around the extent to which performance targets are set as ‘soft targets,’ thereby guaranteeing a minimum level of bonus.
  • Financial institutions account for 23% of the FTSE Eurofirst300 index but only 16% of financial institutions have an ESG-linked remuneration system.
  • Shareholders should engage with companies by voting against unacceptable remuneration packages and calling for and taking part in shareholder dialogue in determining remuneration policy.
  • Regulators should promote active dialogue between companies and shareholders by legislating for a binding “say on pay” vote and setting appropriate guidelines to promote good remuneration practices and disclosure.
  • In the aftermath of the global financial crisis, remuneration policies and specifically the level of bonuses of senior executives of companies and traders continue to hit the headlines.  Investors and regulators have expressed concern that remuneration structures may have contributed to excessive risk-taking and are asking for a stronger focus to be placed on long-term reward schemes and sustainable growth.
  • Much Work Still to Do

    Although steadily increasing, examples of such strategies remain fairly thin on the ground and it is clear that much work remains to be done in strengthening their influence.  For example, a 2009 research paper written by academics at IESE Business School and Arizona State University found that in general firms with an explicit environmental pay policy and an environmental committee do not reward environmental strategies more than those without such structures, suggesting that these mechanisms often play a merely symbolic role.

    A major challenge: linking today's compensation package to policies and practices whose impact may not be felt for many years to come.

    One means of improving the situation, as outlined in a recent report by a group of advocacy organizations that included the U.K.'s PLATFORM and Friends of the Earth, could be to link executive pay to companies’ long-term financial, environmental and social performance, for example through company bonds and equity held in escrow accounts for directors and released after 10-20 years.

    Debates over corporate governance and accountability in the wake of the recent global financial crisis have already highlighted the crucial importance of top executive pay policy as a means of influencing business behavior.  The reports and initiatives outlined above extend this reasoning, by revealing that management remuneration packages are now also recognized as an increasingly important weapon in the armory of campaigners seeking to achieve sustainability objectives.

    Andrew Williams (TheGreenExpert@btinternet.com) is a U.K.-based freelance writer.

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