The Green Bonus

With the rise of esg factors influencing company bonuses, its inclusion and the unequal pay distributions seen in corporate governance beg the question if executive pay can ever be sustainable?

In January, Apple became the next big business to announce the inclusion of some sustainability indicator in their metric for calculating executive bonuses. So, for the first time, the CEO and other executives at the stock-market’s largest company will have 10% of their annual bonus linked to ESG (Environmental, Social and Governance) performance. Pinning sustainability issues, which embrace diversity and inclusion, labour rights and carbon emissions, to executive remuneration has become an increasingly popular corporate governance decision. Apple is in good company and has joined the likes of:

Supermajor oil and gas company – BP: where 20% of executive bonuses are reliant on environmental factors including emissions reductions in line with their net-zero targets and reaching their goal of halving their carbon intensity. 

British multinational telecommunications company – BT: where 10% of their executive overall bonus will depend on the company’s sustainability goals of promoting digital skills and achieving their quantitative environmental targets.

Luxury French fashion house – Kering: who owns Gucci, Alexander McQueen and Balenciaga, has 30% of their executive pay framework depended on ESG performance split evenly between, corporate social responsibility, sustainability and organisation & talent management.

The trend of including environmental or sustainability factors in executive payment plans means creating a financial incentive for high-level management to promote responsible business and properly pursue the company’s sustainability targets. It also recognises the financial value of being sustainable; by emphasising it in executive pay, a company acknowledges that being sustainable generates shareholder value. The increasing shift to include ESG accountability in executive remuneration mirrors the movement in a recognition that being a responsible business is ‘good for business’ and cements the importance of non-financial disclosures. In evaluating a company’s success and potential, merely considering the financial statements is no longer enough. 

it is important to be transparent and clearly report which indicators are being used and how they are calculated

However, the key to ensuring the legitimacy of this inclusion is transparency. Sustainability indicators are notoriously harder to quantify than financial Key Performance Indicators (KPIs). For example, calculating customer satisfaction or company culture does not come with the same ease as quantifying return on capital. Therefore, it is important to be transparent and clearly report which indicators and being used and how they are calculated. In Kering’s remuneration package, ESG factors are impressively balanced with other KPIs, as it influences 30% on annual bonuses. Yet the vocabulary used to describe their financial and non-financial criteria is a red flag: quantitative and qualitative. By characterizing their 30% ESG criteria as qualitative it minimises the accountability attached to upholding targets. Only by pushing quantitative data to measure sustainability initiatives can it hold the same presence as financial disclosure. Nina Rohrbein, writer for Investments & Pensions Europe, noted that “when a company is subjected to scrutiny about a metric and it turns out that it is entirely subjective without any methodology behind it, it is unsatisfactory to investors.”

Executives are also encouraged to outperform their financial indicators up to 125% of the target while only 100% applies for sustainability factors. This suggests that they aim to overperform financially but the expectations are not there with regards to ESG. Although the inclusion of non-financial criteria is a move forward for considering sustainability as a viable business strategy, here it is obvious here that it is not on par with financial criteria. 

A report by PwC found that “85% of the companies with an ESG measure have a metric related to governance (e.g. health and safety or risk). Social (48%) is the second most prevalent bonus ESG measure type with environmental (37%) being the least common”. Conversely, when people think about ‘ESG’ or ‘sustainability’, it is the environmental factors that are thought of most frequently. But, according to PwC, this is not what is echoed in corporates’ consideration within executive pay. Although social and governance responsibility are equally as important as environmental considerations in creating a sustainable business, this misrepresentation is disheartening when trying to link sustainable bonuses with environmental goals. 

Debate may surround the success and ambiguity of linking ESG factors to executive remuneration, but the larger sustainability issue at hand is the amount. Executive pay has been increasing exponentially over the past decades. The Equity Trust’s pay tracker estimates that a FTSE100 CEO earns on average £5.3 million a year. In 2020, this was around 84 times the amount of the lowest paying employee. The oil and gas industry is the most extreme with a pay ratio of 130:1 The vast difference between employee pay and that of executives questions whether workers’ performance is rewarded to the same extent as those higher up. The success of a business cannot be solely reflected in the bonuses of a few executive employees. Would it not be better to reflect the success of your business by your ability to pay everyone well?

BrewDog, a Scottish multinational Brewery and pub chain, have a strong alignment with sustainability and have announced a fixed pay ratio of 7:1. This means that no one in the company can be paid more than seven times that of their lowest paid employee. So, in order for the CEO’s salary to increase, or get a large bonus whether it’s related to ESG factors or not, the lowest paid employee will have to see the same proportionate rise. ‘Taking the team with you’ in this sense can help generate a strong team culture instead of the resentment of realising someone spending less time in the office than you can earn, in Ocados’ case, up to 2,820 times more than you.

Would it not be better to reflect the success of your business by your ability to pay everyone well?

Overall, executive pay is a controversial topic. Recent trends of including non-financial ESG factors as determinants helps put a greater focus on what companies report as their greatest asset: their people. It could help align the interests of senior management with employees, creating a more inclusive company culture and the interests of the society. Yet there is still a lot to be desired in terms of ensuring transparency and authenticity with the indicators used and above all, a green executive bonus cannot be sustainable without considerations for the rest of the company. A CEO earning over 2,000 times more than another employee seems unfair and does nothing to address the inequality issues that are increasingly apparent in today’s world.

When next year’s remuneration strategies come out it will be interesting to see how the hardship of the pandemic has influenced both a shift away from financial indicators, but also recognising that paying one employee millions and another minimum wage is just not right. Maybe the diminished financial performance will push ESG considerations to the forefront of executive remuneration, while the financial hardship felt by companies and individuals alike will turn the tide on extreme pay gaps as corporates begin to realise the value in pursuing  people over profits.

Art by Eilidh Gilmour