We believe the time is ripe for a fundamental rethinking of the variables that should be included in compensation plans, anchored around longer-term incentives linked to the underlying performance of the organization, along with the inclusion of non-financial metrics such as social and environmental targets.
This is not corporate altruism; helping society is in executives’ long-term self-interest. A growing body of research has linked higher value creation with better ESG performance through top-line growth, cost reductions, productivity gains, asset optimization and deregulation. Investors know this, and they are taking action.
Use of restricted or deferred share models is growing
First and foremost, companies must ensure pay and incentive plans are aligned closely with business performance. Amid the economic dislocation of COVID, we believe that chief executives should be sharing the pain experienced by wider society, especially those in sectors hit hard by the pandemic, such as hospitality and travel.
Yet, some companies have thrived during COVID, and the initial sharp economic downturn has been followed by a rapid recovery in many developed countries. Some organizations have provided a valuable public service during COVID, and have supported their local communities.
If a bonus is warranted, companies may prefer to defer awards for executives until the pandemic is over, especially with investors rebelling over generous payouts. BT’s top executives, for instance, offered to voluntarily waive their cash bonuses for two years after the British telecoms group disappointed investors when it scrapped its dividend during COVID.
Deferred bonuses better align risk with performance, and link pay to the longer-term financial health of the organization: since the financial crisis, banks have been forced to award senior executives over several years, for instance.
More recently, companies have been urged by their investors to adopt restricted or deferred share models, where part of an annual bonus is paid only when performance conditions are met over a longer period, or even after an executive’s retirement. These models can help to provide greater simplicity and save time on target-setting and executive pay, while ensuring long-term alignment and behavior.