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Time for executive salaries to take ESG into account

PROFITS are not the be-all and end-all of business, according to the chief executives of JPMorgan Chase & Co, the Coca-Cola Company, General Motors Co and other members of the Business Roundtable group of American bosses.

Their statement last year disavowing the primacy of shareholders and emphasising that businesses should be run for the benefit of all stakeholders - including customers, employees, communities and suppliers - left at least one big question unanswered: If the purpose of business is more than just creating value for shareholders, don't executives need to be incentivised to do more than just increase profit and the share price?

So-called "environmental, social and governance" issues - known by the acronym ESG - have become a prime concern for investors who manage trillions of dollars of capital. "Over time, companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing scepticism from the markets, and in turn, a higher cost of capital," BlackRock Inc's boss Larry Fink wrote in his annual letter to CEOs this week.

Perhaps it is time, then, that these topics are given greater emphasis in executive compensation plans. If you think that sounds borderline Marxist, I will remind you that Klaus Schwab, founder of the World Economic Forum - a mountainside schmooze-fest for the one per cent that takes place next week - has proposed something very similar.

Two recent examples - one from each side of the Atlantic - illustrate why executive pay is ripe for reform. In the UK, the former boss of homebuilder Persimmon plc was awarded £85 million (S$149.5 million) for two years' work, mainly because generous government home-purchase subsidies helped inflate his company's sales, dividends and stock price. A damning independent review subsequently exposed the company's shoddy construction practices.

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Meanwhile, Boeing Co executives were richly rewarded for increasing earnings, cash flow and the share price, but that appears to have come at the cost of a rotten corporate culture that browbeat regulators, squeezed suppliers, devalued engineering and hurried an unsafe aircraft into production without adequate pilot training.

Plenty of companies already set non-financial strategic targets to align executive compensation with important corporate initiatives and customer satisfaction. Some airline bosses get paid less if planes are consistently late or too much baggage goes missing, for example. In the mining and oil industries, it is common to cut rewards if there are fatal accidents or serious injuries.

Elsewhere, though, it is pretty rare for executives to be offered incentives to achieve ESG targets, such as cutting carbon emissions. About one-fifth of the Stoxx Europe 600 and about one-quarter of S&P500 companies link director compensation to ESG achievements. For the natural resource-heavy FTSE 100, the proportion is about one-third, according to Bloomberg data.

Even these pioneers tend to link only a small portion of total pay to ESG goals - typically a chunk of the annual bonus.

Instead, the vast majority of more lucrative long-term incentive plans are still based on profit and stock performance, according to a recent FTI Consulting and CGLytics analysis of UK and Irish compensation practices. "We anticipate greater pressure from investors on companies to align management incentives with ESG-related metrics," the authors concluded.

Some companies are getting ahead of the curve. At life sciences and material sciences company Royal DSM NV, 50 per cent of long-term pay incentives are linked to energy efficiency and greenhouse gas emissions improvements. Oil major Royal Dutch Shell plc, mining group BHP Group Ltd and German engineering company Siemens AG have all announced plans to bolster the link between pay and cutting emissions.

For some observers, rewarding executives simply for doing the right thing can seem perverse and unnecessary. They argue that there is no contradiction between pursuing long-term financial success and being a good corporate citizen, although there are plenty of industries that last pretty well without being virtuous.

I am more sympathetic to the argument that compensation plans are already too complex and opaque. Unless ESG-related pay metrics are clear and quantifiable, it might be difficult to hold executives to account. "Accountability to everyone means accountability to no one," the Council of Institutional Investors complained last year.

Sometimes, though, trade-offs between profits, people and the planet are unavoidable. The climate crisis demands that a company makes investments now that might impair short-term profitability but which will position the business to thrive in the difficult decades ahead. The same goes for paying workers a decent wage, which will enable a thriving middle class. Executives should not be penalised for doing the right thing, just as they should not reap rewards for neglecting their non-investor stakeholders such as customers, staff and the public (as was the case with Boeing, Persimmon and Volkswagen AG's diesel scandal).

One way to satisfy those purists who say shareholder value trumps all might be to maintain the financial emphasis of executive incentive plans but apply a sustainability adjustment, as German utility RWE AG, ThyssenKrupp AG and others do. The formula works something like this: So you achieved your profit targets? Good. But did you do it without screwing up the planet or screwing over suppliers? If not, you are only getting a fraction of your bonus.

Of course, if the Business Roundtable's conversion to stakeholder capitalism is to be more than just good PR, the quantum of executive pay might need rethinking too. Would an executive who treats shareholders, employees and communities equally accept pay that is more than 100 times the typical worker? Or would they settle for less? BLOOMBERG

  • This column does not necessarily reflect the opinion of Bloomberg LP and its owners

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