Any True ESG Focus on Executive Pay Needs a Link to Employee Engagement

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Too often “of material value to shareholders” is used as the great duck out on fundamental questions of human values.

More than half of the 100 Financial Times Stock Exchange CEOs have had their salaries frozen this year. The news comes from a PwC analysis of the first 50 FTSE 100 companies to publish their 2021 annual remuneration reports. It is early in the annual general meeting (AGM) season, and the spotlight is firmly on executive pay in the FTSE100 as investors demonstrate their power. It appears that calls by stakeholders for post-pandemic “fairness” are having an impact. But is this seeming boardroom awareness of broader societal expectation a nod to company reputation, or a strategic imperative? For executive pay policy to earn its place as a business’ recognition of the true value of “Social” in ESG, it must run alongside a rethink of pay incentives for better employee engagement.

Of companies that have published their annual reports, nearly a third have either waived, cancelled, or reduced 2020 annual bonuses. Long-term incentive plan grants for this year have also been revised in light of the economic damage the pandemic caused. Forty-five percent of companies have made some adjustment to their award, and eight out of 10 FTSE 100 companies will have aligned incumbent pension levels with those for the wider workforce by the end of 2022.

The sense of wellbeing among any workforce is bound to have an impact on its productivity.

“This reflects the underlying commercial reality for many businesses, but also illustrates that remuneration committees are taking into consideration the wider stakeholder experience and the associated tone set by proxy agencies and shareholders in the run up to this AGM season,” said Phillippa O’Connor, reward and employment leader at PwC.

Almost half of FTSE 100 companies, according to another recent report from PwC and the London Business School, have linked executive pay to environment, social, or governance targets as investors step up pressure on companies to adopt these goals. Just over a third have an ESG measure in their bonus plans, while in the FTSE 100, roughly one in five include such targets in their long-term incentive plans.

Tom Gosling and Hayes Guymer, the report’s authors, say their work shows “how ESG targets are shifting from traditional areas such as employee engagement and risk towards newer stakeholder concerns around the environment, sustainability and diversity.” Their purpose is to assess the ESG targets used in pay against the Sustainability Accounting Standards Board (SASB) Materiality Map, which identifies the ESG factors that are material for each industry.

“Although most targets relate to material factors, nearly half do not, raising questions about the suitability of targets being used,” a summary of the report notes. “Most investors are making it clear they expect companies’ ESG activities to focus on the areas that contribute to long-term shareholder value.”

But the S in ESG is not about sustainability in the environmental sense, it is about the societal impact of businesses, and the way in which they are run. Although the urgent issues around climate change and the destruction of the natural balance of the ecosystem have propelled the popularity of ESG in recent years, the pandemic is likely to have the largest impact on the steady rise of S concerns among investors. Those are concerns around the treatment of human capital. Growing investor focus on the need for diversity in leadership teams is born out of the recognition of the need for representation, and better use of talent, but fundamentally also about equality of gender and race. In 2021, sustainable businesses need to demonstrate they are committed to equality on every level.

One of the purposes of the PwC/London Business School report seems to be to demonstrate that “nearly half of the current ESG metrics are not linked to material ESG factors”—hence the use of the SSAB materiality map. “Of the 45% of targets not deemed material in the SASB framework,” the report states, “nearly half (45%) relate to employee engagement or diversity and inclusion—whether this should be deemed immaterial will be a matter of debate.”

The rising focus on ESG measures on pay in the plans of the FTSE100—10 percent up on 2019 to measure 45 percent of businesses in 2020, judging by their annual reports—can surely only be a development to be applauded. It is in line, too, with the messaging from the UK Corporate Governance Code and a raft of regulation. Too often “of material value to shareholders” is used as the great duck out on fundamental questions of human values.

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Complicated tomes in corporate governance circles that set out to blast away the importance of stakeholder recognition in governance often make circular arguments to reinforce a particular point of view. As we well know, the fear of change among vested interests is a strong component in much corporate culture, and as the issue of executive pay steps firmly into the spotlight, the barrage of reports will continue to come.

But if U.K. business is to echo the government’s message of the importance of “fairness” in rebuilding after the pandemic, then employee engagement needs to be considered at the table in the same conversation as executive pay. The sense of wellbeing among any workforce is bound to have an impact on its productivity.

The last post I wrote on Board Talk looked at how, in the economic fall-out of the pandemic, business has reacted at speed to the challenges of how best to manage the expectations of the workforce and also to cut costs. I said that this is now an excellent opportunity to make great strides on a stalling agenda on diversity and inclusion: “As flexible working becomes adopted more widely, it will be interesting to see what adoption of the trend reveals about corporate culture, and how in touch it is with the human realities of its human capital.”

In other words, to what extent does any business know how its workforce is faring, and what it thinks on a variety of issues. With CEOs and boardrooms increasingly under pressure to take a stance on social change, reflected in areas such as climate activism and the #MeToo and #BlackLivesMatter global movements, they cannot afford not to have a sense of the employee culture that is an essential component of corporate culture. Employee engagement is even more critical now than before the pandemic.

There’s also nothing quite like money to create a sense of “us and them.” To avoid a growing sense of rift, measures to rein in executive pay could be accompanied by the fairer distribution of pay throughout the business, taking a pandemic-induced sense of awareness that we are all, indeed, in the same boat a step further in a positive way.

Another report just out, by the cross-party think tank the Social Market Foundation, looked at the effect of share-ownership schemes offered by businesses. It found that, among the U.K’s worst-paid workers—those in the bottom 25 percent—employees included in their employer’s share-ownership scheme were, on average, £10,900 wealthier than those without access to these schemes.

“Evidence suggests that employee share ownership could play a role in tackling the U.K’s productivity crisis, improving economic growth, innovation and outcomes for employees such as higher wages,” the report states. “Share plans could also be an important tool for bolstering the financial resistance of U.K households.”

To address barriers to participation and the rollout of employee share plans, the report makes a series of policy recommendations, including “the introduction of a new ownership model to encourage employee share ownership and to form a key part of business success planning.” More than 14,000 U.K. companies already offer such plans. Others may be interested in the implications for talent retention of the requirement that the employee stay with the same employer for five years to get the full benefit.

Now that sounds like ESG, and brings together many necessary threads in the quest for business that serves society well.

Dina Medland, her co-author is a long-time journalist and independent commentator with a mission to provoke thought around responsible capitalism in changing times. She writes about the need for better corporate governance and a return to the value of an ethical focus for better, sustainable businesses on Board Talk. Follow her on Twitter @dinamedland.

This article was originally published on Board Talk and is reprinted with permission.