How to Calculate a Bonus That Everybody Loves

(Bloomberg Opinion) -- Profits aren't the be-all and end-all of business, according to the chief executives of JPMorgan Chase & Co., the Coca-Cola Company, General Motors Co. and other members of the Business Roundtable group of American bosses.

Their statement last year disavowing the primacy of shareholders and emphasizing that businesses should be run for the benefit of all stakeholders — including customers, employees, communities and suppliers —  left at least one big question unanswered: If the purpose of business is more than just creating value for shareholders, don't executives need to be incentivized to do more than just increase profit and the share price?

So-called “environmental, social and governance” issues — known by the acronym ESG — have become a prime concern for investors who manage trillions of dollars of capital. “Over time, companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing skepticism from the markets, and in turn, a higher cost of capital,” BlackRock Inc.'s boss Larry Fink wrote in his annual letter to CEOs this week.

Perhaps it's time, then, that these topics are given greater emphasis in executive compensation plans. If you think that sounds borderline Marxist, I'll remind you that Klaus Schwab, founder of the World Economic Forum — a mountainside schmooze-fest for the 1% that takes place next week — has proposed something very similar.

Two recent examples — one from each side of the Atlantic — illustrate why executive pay is ripe for reform.

In the U.K. the former boss of homebuilder Persimmon Plc was awarded 85 million pounds ($110 million) for two years work, mainly because generous government home-purchase subsidies helped inflate his company's sales, dividends and stock price. A damning independent review subsequently exposed the company's shoddy construction practices.

Meanwhile, Boeing Co. executives were richly rewarded for increasing earnings, cash flow and the share price, but that appears to have come at the cost of a rotten corporate culture that browbeat regulators, squeezed suppliers, devalued engineering and hurried an unsafe aircraft into production without adequate pilot training.

Plenty of companies already set non-financial strategic targets to align executive compensation with important corporate initiatives and customer satisfaction. Some airline bosses get paid less if planes are consistently late or too much baggage goes missing, for example. In the mining and oil industries it's common to cut rewards if there are fatal accidents or serious injuries.

Elsewhere, though, it's pretty rare for executives to be offered incentives to achieve ESG targets, such as cutting carbon emissions. About one-fifth of the Stoxx Europe 600 and about one-quarter of S&P500 companies link director compensation to ESG achievements. For the natural resource-heavy FTSE 100 the proportion is about one-third, according to Bloomberg data.

Even these pioneers tend to link only a small portion of total pay to ESG goals — typically a chunk of the annual bonus.

Instead, the vast majority of more lucrative long-term incentive plans are still based on profit and stock performance, according to a recent FTI Consulting and CGLytics analysis of U.K. and Irish compensation practices. “We anticipate greater pressure from investors on companies to align management incentives with ESG-related metrics,” the authors concluded.

Some companies are getting ahead of the curve. At life sciences and material sciences company Royal DSM N.V., 50% of long-term pay incentives are linked to energy efficiency and greenhouse gas emissions improvements. Oil major Royal Dutch Shell Plc, mining group BHP Group Ltd. and German engineering company Siemens AG have all announced plans to bolster the link between pay and cutting emissions.

For some observers, rewarding executives simply for doing the right thing can seem perverse and unnecessary. They argue there's no contradiction between pursuing long-term financial success and being a good corporate citizen, although there are plenty of industries that last pretty well without being virtuous.

I'm more sympathetic to the argument that compensation plans are already too complex and opaque. Unless ESG-related pay metrics are clear and quantifiable, it might be difficult to hold executives to account. “Accountability to everyone means accountability to no one,” the Council of Institutional Investors complained last year.

Sometimes, though, trade-offs between profits, people and the planet are unavoidable. The climate crisis demands that a company makes investments now that might impair short-term profitability but which will position the business to thrive in the difficult decades ahead. The same goes for paying workers a decent wage, which will enable a thriving middle class. Executives shouldn't be penalized for doing the right thing, just as they shouldn't reap rewards for neglecting their non-investor stakeholders such as customers, staff and the public (as was the case with Boeing, Persimmon and Volkswagen AG's diesel scandal).

One way to satisfy those purists who say shareholder value trumps all might be to maintain the financial emphasis of executive incentive plans but apply a sustainability adjustment, as German utility RWE AG, ThyssenKrupp AG and others do. The formula works something like this: So you achieved your profit targets? Good. But did you do it without screwing up the planet or screwing over suppliers? If not, you're only getting a fraction of your bonus.

Of course, if the Business Roundtable's conversion to stakeholder capitalism is to be more than just good PR, the quantum of executive pay might need rethinking too. Would an executive who treats shareholders, employees and communities equally accept pay that's more than 100 times the typical worker? Or would they settle for less?

In fairness, Persimmon's annual bonus system includes "customer care" and health and safety elements. However, the long term incentive plan which produced this massive payout was based on dividends paid.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

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