14 Oct 2021

Aligning executive compensation to fit the current times and current needs

Executive compensation and how it is designed has been on the radar of investors and other stakeholders for a long time. Investors are always looking closely to ensure there is alignment between performance and how executives are remunerated.

More recently, executives have faced pressure to integrate environmental, social and governance (ESG) issues into compensation plans. This renewed focus on ESG has been strengthened by the pandemic, which put a spotlight on the income inequality between executives and their employees. For example, while some companies were slashing employee pay and making redundancies, executive pay was on the rise. Though some companies announced pay cuts to signal they ‘shared the pain of other stakeholders’, our earlier research on the ASX 300 titled More about pay than performance, which analysed changes to CEO pay in light of the Covid-19 pandemic, suggested that the outcome was quite different. The findings showed that CEO pay had gone up for companies that announced pay cuts compared with our projected pay cut for those companies. Again, our data suggests that the average CEO realised compensation in the S&P 500 increased by more than 20% between 2019 and 2020.

Executive pay in the spotlight

In recent times, we have witnessed outcry in various jurisdictions against awarding huge executive pay that doesn’t link into performance – and this year was of no exception. In the UK, there were several significant revolts at annual shareholder meetings this year. At supermarket group Morrisons, investors were unhappy with the remuneration committee’s decision to use their discretion to award bonuses despite the grocer missing profit targets. Our data shows that the CEO’s granted pay was £5.3m for the fiscal year 2020 compared with £4.46m in 2019. Two other top executives also saw bonuses increase after the remuneration committee decided to discount costs associated with Covid. To register their unhappiness, 70% of shareholders voted against the group’s pay report.

Mining group Rio Tinto also suffered significant revolt against its remuneration report. Shareholders were not content about the company’s decision to award outgoing CEO Jean-Sébastien Jacques a huge bump in his pay despite a mining scandal that hit last year.

On the other side of the globe in the US, Norwegian Cruise Line Holdings saw 83% of votes being cast against its executive compensation report. Shareholders rejected the advisory executive compensation proposal of $36.4m as granted CEO pay for 2020, up from $17.8m the year before, a growth of 104% at a time when the cruise industry was halted due to the pandemic.

An emphasis on sustainable value creation in executive compensation

One of the market perceptions is that most of the key performance indicators in remuneration plans are driven by goals which are focused on the short term and are out of sync with other stakeholders’ interests. With a renewed focus from investors on ESG, issuers are adapting their policies to integrate them in their overall strategy, particularly around climate change and diversity in leadership.

With widespread awareness of climate change, companies and investors have placed a considerable emphasis on becoming more sustainable. The market is also witnessing a change in regulation to fuel this change in strategy. EU’s sustainable finance action plan is one example. Other legislative measures, such as the Shareholder Rights Directive II and the European Green Deal, point to long-term thinking and are pushing corporates and investors alike to serve the benefits of all stakeholders.

This year, The Diligent Institute has carried out a number of studies on the growth of ESG metrics in executive compensation. In our paper titled Aligning Pay, People and Planet, the research suggests that there is a gradual growth of adoption of ESG metrics in executive compensation across the European region. A third (32%) of companies in the region are now incorporating ESG metrics in executive compensation compared with only 8% in 2008. That notwithstanding, the report suggests these metrics are more prevalent in short term compensation compared with the long-term incentive plan, demonstrating that the emphasis on sustainable value creation remains short-term focused.

In designing executive compensation plans, remuneration committees need to ensure that the needs of all stakeholders are considered. When it comes to integrating ESG metrics into executive pay, there is no one size fits all. Remuneration committees need to ensure that they select metrics that align to their materiality as defined by frameworks such as the Sustainability Accounting Standards Board (SASB).

This article is provided by Diligent.