As we head into annual meeting season investors are pouring over proxy statements to look at, among other things, executive compensation.
With some companies, investors will be seeing a new factor affecting executive compensation: climate-related goals. In December, 2018, Royal Dutch Shell announced that it plans to link executive pay to hitting carbon emission targets. This is just the start of a new trend in executive compensation spurred on by major shareholders who see climate risk and opportunity issues as key to the long-term viability of their investments.
Despite the political battles over climate-change measures by governments, the topic is moving to the top of business leader agendas simply as a means of competing more effectively. Competing for customers who are consciously choosing vendors whose policies dovetail with their own; competing for talent who want their work to impact the world and help ensure long-term sustainability of society, and who will steadfastly not work for companies who are not keeping up with critical megatrends; and competing for investors who are looking for forward-thinking institutions in which to invest.
It’s not that executives are unaware since a 2016 survey by the UN and Accenture showed that 98 per cent of executives believe that sustainability is important to the future success of their business.
Executive compensation for the past 30 years has been tied to financial targets and shareholder returns. Despite its popularity, compensating executives for total shareholder return is fundamentally unfair since so much of that return is based on factors beyond their control. CEOs will tell you they focus on what they can control: So why have boards been tying executive compensation to share performance, which management cannot control, and not more on sustainability practices, which they can?
Years ago, in the 1980s, companies were facing issues with quality control in the manufacturing sector, so the boards of directors began to include quality metrics into compensation to focus executives on a key factor affecting the bottom line. CEOs liked the idea because they like control. In this case: quality control.
At the turn of the millennium, customer satisfaction was becoming a key competitive differentiator and the service industry began to take notice. But net promoter score – a measure of customer loyalty – hasn’t yet made it into executive compensation, most likely because the calculation of this metric is not seen as scientific enough.
When it comes to management of climate risk and opportunity, the business case has many metrics from which to choose. For Royal Dutch Shell, it is cutting carbon emissions. Every business leaves a carbon mark so measures to reduce that footprint could be easily adopted. Manufacturers could reimagine products and components, extend product life cycles and reuse materials. Financial services firms could allocate a percentage of capital to climate-friendly projects such as renewable energy, climate-resilient infrastructure or sustainable agriculture. All companies could commit to a percentage of the energy they consume from zero-carbon sources.
The benefits to these measures are also quantifiable. They can bolster a company’s reputation among its stakeholders. They can generate political capital with government regulators (who can grant the company greater freedom of movement or amend legislation and regulations or provide greater tax exemptions). Some climate-related measures can provide a return on investment through reduced energy consumption and waste over the long term. This seems like a no-brainer for a bank that typically does not measure the consumption of electricity from its branches, ABMs or trading floors.
Companies could also support the creation of new products and services to address the urgent needs around the world, such as scarce water supplies, hunger and greenhouse gas emissions. There are companies out there that can use that support, such as Rainmaker.
Boards have little excuse not to include climate risk and opportunity in compensation schedules, since there is so much that has already been done to link corporate social responsibility to executive compensation. A study by the Journal for Business Ethics produced a study An Examination of the Structure of Executive Compensation and Corporate Social Responsibility: A Canadian Investigation. In it, they found “significant positive relationships between: (1) salary and CSR weaknesses; (2) bonus and CSR strengths; (3) stock options and total CSR; and (4) stock options and CSR strengths.”
The findings suggest the importance of encouraging socially responsible actions, particularly for larger Canadian companies. Therefore, compensation can be an effective tool in aligning executives’ welfare with that of the “common good,” which results in companies that can support the transition to a low-carbon, climate change-impacted future, and thrive within it.
Or as the old saying goes: “What gets measured gets done.”
Laura Zizzo is founder and CEO of Mantle314, a climate risk management consulting firm.