John Hodges, Director, Financial Services, BSR
Paris School of Economics Professor Thomas Piketty's best-selling Capital in the Twenty-First Century has generated a lot debate over the causes and potential impacts of income inequality and concentration of wealth. This trend has been particularly pronounced since the 1980s, and following the financial crisis of 2008, the issue has become more prominent: Since 2009, the incomes of the top 1 percent grew by more than 30 percent, while the incomes of the bottom 99 percent grew by less than 1 percent.
Executive compensation has become a symbol of this issue. Last month, the New York Times published its annual list of executive compensation, with Oracle’s Larry Ellison topping the list at US$78 million. Most Fortune 500 CEOs earn several million dollars in pay and often substantially more compensation in stock. And corporate CEO pay even pales in comparison to compensation of their counterparts at hedge funds, where the top 25 hedge fund executives earned average of about US$1 billion in 2013.
In response, many financial analysts and shareholders, including Warren Buffett, have questioned the justification for executive pay at certain companies. They’re not the only ones who have taken notice. In BSR’s own assessments to determine the most important sustainability challenges for our corporate members, a wide range of stakeholders have identified executive compensation as a “material issue.”
This trend has made me wonder: Should executive compensation be considered a corporate responsibility issue?
I have come to the conclusion that it should, but not as it relates to income inequality and the seemingly high levels of executive pay. Executive compensation is increasingly based on pay-for-performance, and stakeholders should therefore ask not only how much money executives are paid but also for how much performance they are paid. Unfortunately, “performance” is often defined narrowly on “total shareholder value” created, which is usually linked to the stock price. Roughly two-thirds of executive compensation is tied to stock-based incentives, and one study found that more than half of all pay-for-performance compensation is tied to long-term equity incentive plans.
This focus on shareholder value, however, excludes the other stakeholders that corporations have. A more appropriate way to determine executive compensation would use a more inclusive measurement: “total stakeholder value”. In addition to shareholders, this would include the corporation’s contributions to employees, customers, communities and society, and the environment. Brand and reputation are important determinants of a company’s long-term value, and how a company manages its environmental and societal impacts affects its brand. A performance measure of total stakeholder value, therefore, would incentivize executives to focus on brand and reputation more broadly, to the ultimate benefit of shareholders as well.
A few companies do tie executive compensation to corporate sustainability performance. Intel, for example, links a portion of all employee (including executive) compensation to the achievement of environmental sustainability metrics. At Shell, sustainable development accounts for 20 percent of employee evaluations, and it is linked to bonuses. Barclay’s Balanced Scorecard, which contains many aspects of corporate citizenship, is also a factor in determining employee remuneration.
According to a study by the IRRC Institute, these companies are in the minority: Only six Fortune 500 companies place sustainability oversight functions within their “compensation” or “remuneration” board committees. If sustainability is truly the defining issue of this century, and major sustainability events can swing a company’s value over night, it would be smart business for companies to incorporate sustainability performance into employee compensation, especially for executives. And gauging by growing stakeholder interest in executive compensation, I expect sustainability pay-for-performance to converge with corporate sustainability reporting. I look forward to the day when every corporate sustainability report clearly articulates how executive compensation was linked to corporate responsibility in a measured manner.