27 Aug 2020

How responsible reward practices are shaping performance and incentive strategies

Responsible Reward covers a wide philosophy that connects the external environment, business practice and remuneration. This stemmed from Responsible Investment, which is part of the Global UN Sustainable Development Goals initiative. It explicitly acknowledges ESG (environmental, social and governance) factors to the performance and profitability and long-term health and stability of the business and of the market/sector it operates within.

ESG should be part of every organisation’s strategy, regardless of whether they want to use them for investment reasons. At the heart of it, ESG essentially means that companies are more likely to succeed and deliver strong returns if they create value for all their stakeholders, employees, customers, suppliers and wider society including the environment.

More and more companies, particularly in Europe, are linking executive pay to sustainability metrics to ensure that the ESG agenda is being driven from the top and the philosophy becomes embedded within the culture of the organisation. ESG measures are also often included within annual bonus/short-term incentive plans (STIPs) but are increasingly also reflected in long-term incentive plans (LTIPs), whether it be cash or share-based awards. However, there is still a long way to go regarding this, as this is still not mainstream practice.

Research undertaken by Institutional Shareholder Services (ISS) shows that over time, companies that prioritise social responsibility may significantly outperform companies that don’t. There are five key areas of ESG that are likely to fall into the Reward remit: employee wellbeing, customer satisfaction, diversity and equal opportunity, executive pay and management structure, and health and safety.

Employee wellbeing: benefits aimed at improving the lives of employees, improves employee satisfaction and improves attrition. Companies with policies and practices in place that will help them to attract and retain talent will perform well in this.
Customer satisfaction: how a company treats its customers may reflect on company values and culture. Companies that score well in this area have a track record of being responsive to customer needs, treating customers fairly and setting fair prices and terms for the sale of goods and services. Companies that meet and exceed customer expectations will score well in this category.
Diversity and equal opportunities: companies with a dedicated approach that are inclusive and ensure equal opportunity to all communities, and have policies and practices in place that protect groups from discrimination.
Executive pay and management structure: the extent to which a company follows best practices with respect to executive pay schemes, how executive pay compares to peers, whether pay is aligned with performance and practices regarding company equity, are all considered under Corporate Governance, as is the ownership structure of a company, shareholder rights, majority voting provisions and whether there is a controlling shareholder block.
Health and safety: how an organisation is approaching mitigating the risk for safety incidents in the workplace, is a good indicator of whether an employer is taking sufficient steps to create a safe work environment for employees and customers.

We are seeing more and more examples in industry where established organisations are expanding their responsible reward offering and incorporating elements of ESG into their wider reward strategy. For example, Shaftesbury Plc have 20% of their annual bonus linked to environmental sustainability, aligning directly with one of their core values of being responsible. Royal Mail now includes employee and customer focused metrics in its STIP. In 2019, the company proposed a simplified bonus structure, based on 75% financial and 25% non-financial metrics. This replaced a more complex structure, which had included three different safety metrics, an employee engagement score, a customer satisfaction score, and three measures of service quality and productivity. However, its LTIP remains based purely on financial metrics.

Other businesses like HSBC & National Australia Bank have created specific ESG reports that detail their approach to sustainable growth. National Australia Bank, for example, has a scorecard of commitments that link directly to their sustainability goals, including environmental operational goals such as reducing energy and water use, to social goals such as achieving 40–60% of either gender represented at all levels of the business by 2020 and a 50% increase in volunteering days on the previous year.

Some organisations such as Bloomberg have created dashboards with specific ESG indices and metrics where you can compare your company to your peers on metrics such as ratio of women in management or average age of board members.

Changes in the design of incentive plans, with the inclusion of more diverse measures in the form of ESG metrics can demonstrate a focus on long term sustainability. However, it is not always as straightforward as pulling a few metrics out the air and expecting a round of applause from investors or stakeholders or a change in culture. Simply aligning ESG metrics, in isolation, will not create the desired long-term change. For ESG metrics to really work and be meaningful you need to ensure you understand:

Purpose: what is the purpose of your organisation, and how do ESG factors support your organisation’s purpose?
Accountability: who are the key stakeholders in your organisation, and what ESG factors are important to them specifically?
Alignment: how can you align your incentive plan participants with material ESG factors to ensure clear line of sight between their actions, behaviours and performance? For example, are measures better addressed at an individual or team level, or corporate-wide?
Engagement: how do you ensure that participants remain engaged? How do we ensure that they really understand the measures, and communicate how important they are and how well the organisation is tracking against them?

Naturally, many of our clients are wanting to develop their Responsible Reward strategy further, which encouraged us to create our Elevating Responsible Reward Audit. The only way to get Responsible Reward on the agenda is to measure and track, starting with a review on where you are currently. From there, by reviewing your reward practices with a focus on each of the ESG principles, you can begin to elevate your Responsible Reward offering, tracking your organisation’s effectiveness along the way and pinpointing areas that need strengthening.

If you are looking to improve the responsible reward strategy in your organisation, then incorporating your ESG goals into your incentive plans could be the perfect next step. Encouraging both employees and leaders within the business to align their behaviours to your strategic goals with strong long-term and short-term incentives can further support the performance and profitability of the business.

This article is provided by Innecto Reward Consulting.