Time to Tie Exec Comp to Sustainability Performance? Some Folks Think it is Time -- and How to Do It

For the past 25 and more years, the focus of the sustainable & responsible investment (SRI) community has been on matters related to corporate compensation, usually a corporate governance concern, as well as additional concerns on a range of other issues and topic areas (in environmental, social/societal, and other categories).

We'll often see "executive compensation" in the media headlines when a corporate crisis occurs -- often, the narrative will include descriptions of the underperformance of the company and the overly handsome compensation of the folks at the top of the pyramid -- the C-suite. It's a recurring theme.

Exec Comp has been a concern (particularly for investors) for several decades now. In the late-1980s things began to change quite dramatically in "exec comp," the salary plus a range of benefits allocated to the CEO and C-suite executives by the board of directors.  The ratio of perhaps 100-1 (CEO pay to rank & file) began to soar to 300-to-1, 400-to-1, and even more.  Today one expert sets the ratio at 373 times -- CEO to blue collar worker in the firm.

Reacting to public pressure, when the tax deductibility of the "cash" amount paid to the CEO was limited to just $1 million by the Congress of the United States in 1993.  (Congress enacted Section 162 of the Internal Revenue Code to put the cap in place for senior management.)

That, it was thought, would serve to rein in runaway CEO salaries.  And would help to create a better balance between workforce salaries and the C-suite.  And would create many more incentives for reward performance (stock grants, options, etc).  And would serve the rank & file of the enterprise by lifting their salaries.

Instead, we saw a takeoff, hockey-stick-style, of non-cash compensation to the senior management team.  As a Harvard Law School Forum on Corporate Governance commentator (Michael Doran, University of Virginia) observed in his commentary in February -- "More than two decades on, Section 162(m) has proven a spectacular policy failure."
So what adjustments might we make in addressing the issue?  These were explored by Professor Doran -- you can see them in the link here.

A new wrinkle that makes a lot of sense:  How about tying some exec comp to the company's sustainability performance? This is explored by Seymour Burchman and Barry Sullivan, both compensation consultants, in the Harvard Business Review (our Top Story).

They compare an analogous situation at an earlier time (the 1980s) when exec performance on improving "quality" in U.S. manufacturing firms began to be incorporated in considerations of compensation at the top.  This helped to focus executive attention on the firm's quality of initiatives and achievements (and linked that to compensation metrics). (Remember "Six-Sigma, Zero Defects" and other initiatives?)

And so today, they suggest, it is time to do the same thing for corporate sustainability. This may not happen in the broad universe of public companies immediately, but over time, they argue, clearly articulated business cases and specific plans for improvement will help to add sustainability considerations to the comp discussions and negotiations. 

The reasons "why" are important and the authors spell these out.  The concept is to avoid foggy, undefined goals and get to the details and well-defined sustainability metrics in the compensation discussions.  
How far do we have to travel?  The research showed only 2% of companies in the S&P 500(r) universe currently tie environmental metrics to exec comp, and only 2.6% had a diversity metric.

There are more powerful arguments set out for you in our Top Story this week.  This is a conversation that may gain significant traction as companies begin to trot out the required ratio between the CEO comp and the median pay level for the rest of the team members (the disclosures start in 2018 unless there are Federal policy changes). 

The earlier interesting February 2017 commentary by Professor Michael Doran is here: https://corpgov.law.harvard.edu/2017/03/03/uncapping-executive-pay/

This is just the introduction of G&A's Sustainability Highlights newsletter this week. Click here to view the full issue.